chapter 14 starting early: retirement and estate planning 1 copyright © 2016 mcgraw-hill education....

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Chapter 14Starting Early:

Retirement and Estate Planning

Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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Retirement PlanningChapter Learning ObjectivesLO14.1 Analyze your current assets and

liabilities for retirement and estimate your retirement living costs.

LO14.2 Determine your planned retirement income and develop a

balanced budget based on your retirement income.

LO14.3 Analyze the personal and legal aspects of estate planning.

LO14.4 Distinguish among various types of wills and trusts.


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Misconceptions About Retirement Planning

You have plenty of time to start saving for retirement …Saving just a little bit won’t help …You’ll spend less money when you retire …My retirement will only last 15 years …You can depend on Social Security and a company

pension to pay your basic living expenses …Your pension benefits will increase to keep pace with

inflation …Your employer’s health insurance plan and Medicare

will cover all your medical expenses when you retire…

Learning Objective LO14.1 Analyze Your Current Assets and

Liabilities for Retirement and Estimate Your Retirement Living

Costs


Saving for Retirement: TipsStart Now—Time is criticalIf necessary, start smallUse automatic deductions from your payrollSave regularlyBe realistic about returnsIf you change jobs, keep your old retirement

account or roll it over to new oneDon’t touch your savings early, unless you

absolutely have to

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The Importance of Starting Early

Take advantage of the time value of money◦Start at age 25:

Invest $127 a month At 11% APR For 40 years

◦Start at age 50: Invest $ 2,244 per month At 11% APR For 15 years

N = 480 monthsI/Y = 0.9167 = 11%/12PMT = -127 PV = 0 FV CPT = $1,092,216

N = 180 = 15 yrs x 12I/Y = 0.9167PMT = - $2,244PV = 0 FV CPT = $1,020,362


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Conducting a Financial AnalysisAssets - Liabilities = Net Worth

◦ Ideally net worth should increase each yearHousing

◦If owned, probably your biggest single asset◦If large equity, a reverse mortgage could

provide additional retirement income◦Sell your home, buy a less expensive one, and

invest the difference


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Conducting a Financial AnalysisLife Insurance

◦May reduce coverage as you near retirement and children are self-sufficient

◦Increase income by lowering premiums Other Investments

◦After retirement, consider changing your objective from growth to income


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Estimating Retirement Living Expenses

Spending patterns and where and how you live will probably change

Some expenses may go down or stop:401(k) retirement fund contributionsWork expenses - less for gas, lunches outClothing expenses - fewer and more casualHousing expenses - house payment may stop

if your house is paid off Federal income taxes

will probably be lower


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Estimating Retirement Living ExpensesOther expenses may go up

Life and health insurance, unless your employer continues coverage

Medical expenses increase with ageExpenses for leisure activities Gifts and contributions

Inflation will increase amount needed to cover expenses over the course of retirement


How an “Average” Older (65+) Household Spends its Money

14-10Source: U.S. Bureau of Labor StatisticsCopyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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Learning Objective LO14.2 Determine Your Planned Retirement Income and Develop a Balanced Budget Based on Your Retirement Income

Major Sources of Retirement IncomeEmployer Pension PlansPublic Pension PlansPersonal Retirement PlansAnnuities


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Employer Pension PlansDefined Contribution

An individual account to which the employer contributes a specific amount annually◦Money-purchase pension plans

% of earnings set aside annually, along with any employer contributions

◦Stock bonus plans Employer’s contribution buys stock in your

company for you◦Profit-sharing plans

Employer’s contribution depends on the company’s profits


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Employer Pension Plans Defined Contribution

401(k) plan◦Salary-reduction plan◦Employer makes non-taxable contributions

and reduces your salary by the same amount

◦Employee contributions are tax-deferred◦Some employers match a portion of your

contribution◦Funds invested in stocks, bonds, and mutual

funds◦Vesting period


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Employer Pension PlansDefined Benefit

Employer will pay you a certain amount per month when you retire based on:

◦ Pre-retirement salary ◦ Number of years of service

Employers make the investment decisions for your contribution and theirs

Your benefit amount stays the same regardless of how the investments perform


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Employer Pension PlansPortability of Plans

◦Allows you to carry earned benefits from one employer’s pension plan to another when you change jobs

ERISA◦Employee Retirement Income Security Act of 1974

◦Sets minimum standards for pension plans◦Federal government insures part of the

payments promised by defined-payment plans


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Public Pension Plans

Most widely used source of retirement income, covering 97% of U.S. workers

Meant as part of your retirement income, not the sole source

Check the Earnings and Benefit statement you receive each year for accuracy

See www.ssa.gov

Social Security


http://www.ssa.gov/

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Public Pension Plans

Full retirement benefits at age 65 to 67◦Depends on year of birth◦Reduced benefits at age 62◦Full retirement age being increased in gradual

stepsBenefits based on earnings over the

years◦Must earn a certain number of credits to qualify

Certain dependents may receive benefits

Social Security Eligibility


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Personal Retirement AccountsIndividual Retirement Accounts (IRA)

Regular (traditional) IRA◦Allows $5,500 contribution in 2014 and beyond

$6,500 if over 50◦Contribution may be tax-deductible, depending

on your tax filing status and income◦Interest accumulates tax free until you begin

withdrawal◦May begin withdrawing at 59 ½◦Must begin withdrawing at 70 ½◦Withdrawals are taxable income


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Individual Retirement AccountsRoth IRA

◦Contributions are not tax deductible◦Distributions tax free after age 59 ½◦Same contribution limits as traditional IRA

If you are single with an AGI < $129,000 or If you are filing jointly with an AGI < $191,000 Can continue to contribute even after age 70 ½

◦After five years, withdrawals are tax free and penalty free, if: You are at least 59 ½ … or Funds used as a down payment on a first-time

home purchase


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Individual Retirement AccountsSimplified Employee Pension (SEP)

◦IRA funded by the employer◦Employer can make annual contributions up to

$50,000◦Employee’s contributions fully tax deductible◦Simplest retirement plan for the self-employed

Spousal IRA◦Contributions for a nonworking spouse if filing

a joint return◦Contribution limits same as for Roth or

Traditional IRAs


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Rollover IRA◦Traditional IRA allowing transfer of all, or a

portion, of your taxable distribution from a retirement plan or other IRA

Education IRA◦Coverdell Education Savings Account◦May give up to $2,000 per year to each

child under age 18◦Contributions not tax-deductible◦Tax-free distributions for education expenses

Individual Retirement Accounts


Individual Retirement AccountsKeogh Plans

H.R. 10 plan or self-employed retirement plan Designed for the self-employed Annual tax-deductible contributions limited Can be difficult to administer

Limits on Personal Plans Cannot leave money in a tax-deferred

retirement plan forever (except for Roth IRA) At retirement or by age 70½ you must begin to

receive a minimum lifetime distribution

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Types of IRAs


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AnnuitiesProvides guaranteed income for life

◦Purchase with proceeds of an IRA or company pension

◦Use as supplemental retirement income◦Single or periodic payments

Interest accumulates tax free until payments begin; distributions taxed as ordinary income

Immediate annuity = payments begin right away

Deferred annuity = payments begin at some future date


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Living on Your Retirement IncomeEstimate a retirement budget If funds are not enough:

◦First, make sure you are getting all the income you are entitled to

◦Convert assets into cash or sources of income

◦Consider the trade-off between spending and saving

◦Consider working during retirement◦Dip into your nest egg cautiously and consider what you would like to leave for your heirs


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Learning Objective LO14.3Estate PlanningYour estate

◦Everything you ownEstate planning

◦A detailed plan for the administration and disposition of your property during your lifetime and at your death While you work you accumulate funds for your future and

for your dependents As you grow older, your emphasis will shift from

accumulating assets to distributing them wiselyCopyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

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Estate Planning Phases1. Build estate through savings,

investment, and insurance2. Ensure that your estate is distributed as

you wish after your death◦ If married: consider needs of spouses ◦ If single: financial affairs in order for

beneficiaries◦ Make sure important documents are

accessible, understandable, and legally proper


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Legal DocumentsBirth, marriage, and divorce documentsLegal name changesMilitary service recordsSocial Security documentsVeteran’s documentsInsurance policiesTransfer records of joint bank accountsSafe-deposit box recordsAutomobile registration Titles to stock and bond certificates


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Learning Objective LO14.4Types of Wills and Trusts

WillsThe legal declaration of a person’s mind as

to the disposition of his or her property after death

Have an attorney draft your will to avoid difficulties

A standard will can cost between $300-$400


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Types of Wills1. Simple or “I love you” will

◦ Leaves everything to your spouse

◦ Sufficient for small estates2. Traditional marital share

will◦ Leaves 1/2 to spouse, 1/2 to

children of your issue or heirs◦ May be held in a trust

Trust = arrangement by which a designated person manages assets for the benefit of someone else


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Types of Wills3. Exemption trust will

◦ Passes to your spouse except for an amount equal to the exemption, which passes into a trust

◦ Trust can provide a lifelong income4. Stated amount will

◦ Allows you to pass along to your spouse any amount that satisfies the family’s financial needs


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Intestate and ProbateIntestate

◦You die without a will◦The state distributes your assets◦May mean the state will decide on a

guardian for your children◦Very complicated if a “blended” family

Probate◦Probate court generally validates wills and

makes sure your debts are paid◦Expensive, lengthy, and public


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Will Formats Holographic will

◦Will that you write, date and sign, entirely in your handwriting

◦May not be recognized in some statesFormal will

◦Usually prepared with attorney’s assistance◦You must sign and have two witnesses,

neither of whom can be beneficiaries◦Beneficiary = person you have named to

receive property


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Will Formats Statutory will

◦A type of formal will on a preprinted form◦Available from a lawyer or stationery store◦May include provisions which are not in the

best interest of your heirs


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Writing Your WillSelecting an Executor

Executor◦ One who is willing and able to execute the

provisions of your willTasks may include

◦Preparing an inventory of your assets◦Collecting any money due and paying off

debts◦Filing all income and estate tax returns◦Making decisions about investing or selling

assets to pay off debts or provide income◦Distributing the estate and making a

financial accounting to your beneficiaries


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Writing Your WillSelecting a Guardian

A guardian assumes the responsibility for providing the children with personal care and managing the estate for them

Don’t forget any pets in the home!◦They need a guardian, too


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Reasons to review your will◦You move to a new state with different laws◦You have sold property mentioned in the will◦The size and composition of your estate has

changed◦You have married, divorced, or remarried◦Potential heirs born or died

Adding a codicil◦Document that explains, adds or deletes

provisions in your existing will

Altering or Rewriting Your Will


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Living WillLiving Will

◦Allows you to specify whether or not to be kept on artificial life support “Do Not Resuscitate” (DNR)

◦May also appoint someone to make health care decisions on your behalf in case you are unable to do so


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Power of AttorneyPower of Attorney

◦Legal document authorizing someone to legally act on your behalf if you become seriously ill or injured

Health Care Power of Attorney◦Combines a living will and power of attorney

for use in making health related decisions


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Letter of Last InstructionNot legally bindingProvides heirs with informationCould include:

◦Funeral preferences◦Names of people to be notified of your

death◦Location of bank accounts and safe

deposit box◦Assets and debts◦Social Security number◦Disposition of personal effects


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TrustsLegal arrangement through which a

trustee holds your assets for your benefit or that of your beneficiaries◦Trustee may be an individual or an institution

Benefits of Trusts◦Reduce estate taxes◦Avoid probate; transfer assets immediately◦Free you from managing assets◦Provide income for a surviving spouse◦Ensures property serves desired purpose after

your death


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Types of TrustsRevocable trust

◦You retain the right to end the trust or change its terms during your lifetime

◦May avoid the lengthy probate process◦Does not provide shelter from federal or

state estate taxesIrrevocable trust

◦You cannot change the terms once instituted◦Used to reduce estate taxes◦Avoids probate


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Types of TrustsCredit-shelter trust

◦“Bypass trust”◦“Residuary trust”◦“A/B trust”◦“Exemption equivalent trust”◦“Family trust”◦Enables surviving spouse to avoid federal

taxes on a certain amount of assets


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Types of TrustsDisclaimer trust

◦For couples without enough assets to warrant a credit-shelter trust but may in the future

◦Surviving spouse receives everything but may “disclaim” or deny some assets Anything disclaimed goes into a credit-shelter

trust◦Protects wealth from estate taxes


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Types of TrustsLiving trust

◦“Inter vivos trust”; in effect while you are alive◦Property management arrangement◦Advantages:

Ensures privacy: Assets in trust avoid probate Allows review of trustee performance Relieves you of management responsibilities Less likely to create arguments among heirs Can guide family and doctors if you are unable to

make decisionsTestamentary trust

◦Established by your will


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Taxes and Estate PlanningEstate taxes

◦Federal tax on value of property at death◦Tax on fair market value◦$5.12 million exempt in 2012

Estate and Trust Federal Income taxes◦Estates and certain trusts must file tax

returns◦Trusts and estates must pay quarterly

estimated taxes


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Taxes and Estate PlanningInheritance taxes

◦Tax on property left by a person in his/her will◦Imposed by states◦4 to 10% on average

Gift taxes◦Tax on gifts >$14,000 given by one person to

another in a single year◦Imposed by both state and federal

governments


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Chapter SummaryLearning Objective LO14.1 Net worth = Assets - Liabilities Review your assets to ensure they are

sufficient for retirement. Estimate your living expenses.

◦ Some expenses are likely to decrease while others will increase.


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Chapter SummaryLearning Objective LO14.2 Possible sources of income during

retirement include:◦ Employer pension plans◦ Public pension plans◦ Personal retirement plans◦ Annuities

If your income approximates your expenses, you are in good shape; if not, determine additional income needs and sources.


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Chapter SummaryLearning Objective LO14.3The personal aspects of estate planning

depend on whether you are single or married.

Never having been married does not eliminate the need to organize your financial affairs.

Every adult should have a written will. A will is a way to transfer your property

according to your wishes after you die.


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Chapter SummaryLearning Objective LO14.4 The four basic types of wills are:

◦ Simple will◦ Traditional marital share will◦ Exemption trust will◦ Stated amount will

Types of trusts include: ◦ Credit-shelter trust◦ Disclaimer trust◦ Living trust◦ Testamentary trust

Federal and state governments impose various types of estate taxes
