Chapter 18

Learning Objectives (1 of 2)

Define the characteristics of a tax-favored savings program

Explain the key features of the different IRA programs

Compare a Roth vs. a traditional IRA

Describe Keogh, 403(b), and 401(k) programs

Learning Objectives (2 of 2)

Describe an annuity Explain an annuity’s payout options Distinguish between a fixed rate

and variable rate annuity Choose among various annuity

proposals Construct a retirement plan

Characteristics of a Tax-Favored Savings Program

Have at least one or two of the following features, but not all three:

Tax deductible contributions Tax deferral of income Partial or complete tax exemption

of withdrawals

The IRA Programs (1 of 4) (Traditional) IRA

Maximum contribution for 2002 ($3,000 but $3,500 if age 50 or older)

Contribution an adjustment to gross income if AGI less than specified maximum

May always make a non-deductible contribution

Must start withdrawals between ages 59 ½ and 70 ½

The IRA Programs (2 of 4) Spousal IRA

As long as combined income on a joint return exceeds the combined IRA contributions of both spouses, a non-working (or low-income) spouse may also set up an IRA

The IRA Programs (3 of 4) Educational IRA

Contributions are NOT deductible No contributions by people with AGI

over specified maximum In 2002, maximum contribution per

child is $2,000 Withdrawals are fully tax exempt if

used to pay for educational expenses

Educational IRA (4 of 4) Roth IRA

Maximum contribution of $3,000 in 2002 No contributions by people with AGI

over specified maximum All withdrawals tax free if in account for

at least 5 years and recipient over age 59 ½

No minimum required withdrawals (as is the case with a traditional IRA)

Comparison of Roth & Traditional IRAs A Roth contribution is always better

than a nondeductible IRA contribution A comparison of a deductible IRA with

a Roth IRA depends on how one’s current marginal tax rate (MTR) compares with one’s MTR at retirement If higher now, choose deductible IRA If lower now, choose Roth IRA

Keogh Plans Officially known as HR 10 plans For self-employed or small

companies Similar to a traditional deductible

IRA account May be either a profit-sharing plan

or a money purchase plan

401(k)s and 403(b)s Both typically function as defined

contribution plans 401(k)s are available to for-profit

businesses 403(b)s are available to not-for-

profit operations

Annuities A steady stream of consecutive payments Four broad categories of annuities

SPDA's (Single Premium Deferred Annuities). A qualified SPDA would be ideal for an individual taking money from a pension plan, IRA, 401(k) or other tax deferred savings program.

FPDA's (Flexible Premium Deferred Annuities). A nonqualified FPDA would be a form of a savings program for retirement. FPDA's allow you to contribute on a monthly basis.

Annuities (cont.) CD-type annuities. These are similar

to SPDA's, but have guaranteed rates over selected periods of time. Number of payments is exactly defined.

SPIA's (Single Premium Immediate Annuity). Similar to a SPDA, except that the benefit payments begin upon receipt of the single premium.

Payout Options for an Annuity Cash Refund Option: Any cash value in

policy is paid to a contingent payee when annuitant dies

Installment Refund Option: cash value will be paid in installments when annuitant dies

Life with Period Certain:a minimum number of payments guaranteed (usually 5, 10, 15, or 20 years)

Payout Options (cont.) Life or Straight Life Option: All

benefits lost when annuitant dies (highest risk to buyer, but highest payout)

Joint and Survivor Option: sold to couples, reduction in payment when first person dies. May be combined with the other payout options

Fixed vs. variable rate annuity Must choose for accumulation

period (if any), and for payout period

Variable rate policies are tied to some investment (such as a stock mutual fund)

Many people make part of policy fixed rate and part variable rate

Choosing an annuity policy Make sure company issuing policy

is considered financially sound For an immediate annuity, look for

who gives the largest monthly payment

For a deferred annuity: Be comfortable with the underlying

investment Be alert to all possible fees

Constructing a retirement plan Step 1: Project retirement

expenses Step 2: Identify sources and

amounts of retirement income Step 3: Compare projected income

and expenses, and develop a plan to assure adequate income

Projecting Retirement Expenses Bottoms-up approach: construct a

budget for the first year of retirement Use rule of thumb

Take current salary Figure average annual salary increase

between now and retirement Project pre-retirement income, multiply

by 80%

Sources of Retirement Income Social Security retirement benefits

Can obtain estimate from Social Security, or make own projection

Pension Income Withdrawals from tax-qualified

plans Withdrawals from personal assets