planning your financial future, 4e by: boone, kurtz & hearth retirement planning chapter 16
TRANSCRIPT
Planning Your Financial Future, 4eby: Boone, Kurtz & Hearth
Retirement Planning
Chapter 16
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Introduction
Average life expectancy is over 70 years 100 years ago, it was about 55 years so
there wasn’t much need for retirement planning
If you retire when you are 65, you may still have 20+ years remaining and you’ll need money during that time
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Introduction
One fundamental error many people make is not diversifying properly Enron employees, for example
The earlier you start saving for retirement, the easier it is
The key is planning
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Threats and Protections
Threats Inflation Heath-care expenses Cost of long-term care Estate taxes Income taxes State and local taxes
Protections Employer pension
plans Retirement savings
plan Social security Wise investing and
spending Medicare Health insurance Estate planning
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A Time Line for Making Important Choices
The time line starts TODAYDuring your working years, you need to
periodically review you retirement plan By age 50: you should start thinking more about
what you’d like to do during retirement By age 55: you can begin withdrawing money from
several retirement plans without penalty By age 59½: more options are available By age 65: (the “traditional” retirement age) you
become eligible for many important benefits By age 70½: you must begin withdrawing money
from most retirement accounts
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Figure 16.3: How Much Will You Need For Retirement?
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Factors That Determine Your Savings Needs
Your current ageYour current incomeYour desired retirement incomeYour current retirement savingsOther sources of retirement income (Social
Security, etc.)Your tax rateThe expected rate of inflationThe expected return on your retirement
savings
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The Lessons of Saving for Retirement
Start early and stick with itSave as much as you can afford each month
It’s the savings today that will be earning you the most interest on interest
Take advantage of tax-deferred retirement plans
Don’t be too conservative with your investments While you’re young, you can handle fluctuations in
your retirement fundsDiversify your investments
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Figure 16.7: Don’t Wait to Save for Retirement
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Understanding the Social Security System
Old Age and Survivors Insurance Fund Provides monthly benefits to retired workers and
their survivorsDisability Insurance Trust Fund
Provides benefits to partially or totally disabled workers
Hospital Insurance Trust Fund (Medicare Part A)
Supplementary Medical Insurance Trust Fund (Medicare Part B) Provides health-care benefits to elderly Americans
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Social Security
FICA (Federal Insurance Contributions Act) deductions represent the amount you contribute to Social Security Initially, tax was 1% on earnings up to $3,000 Today, rate is 15.3% of earnings up to a set
amount that changes yearly 12.4% goes to Old Age fund and 2.9% to Hospital
Trust fund Earnings above the limit are still subject to 2.9%
Medicare tax Half of tax is paid by you and half is paid by
employer
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Applying for Social Security Benefits
Once you become eligible for benefits, you must apply Provide evidence that you qualify
Birth certificate is generally sufficient Recent W-2 or tax return
The age at which you can receive benefits is rising Currently it’s about 65½, but if you
were born after 1960, it’s 67
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Computing Your Retirement Benefits
Based on what you’ve earned throughout your working life (rather than the last few years of your career)
If you begin withdrawing social security at the ‘normal’ retirement age, your benefit is determined based on the average amount you’ve earned (inflation-adjusted) over the past 35 years Request a Personal Earnings and Benefits
Estimate Statement (PEBES) Make certain it’s accurate (your earnings)
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Other Social Security Issues
Individual vs. family benefits Retired workers as well as dependent spouse and
young children receive benefits Upper limit exists to total Social Security benefits one
family can receive
Survivor benefits If you die (even before you reach retirement age)
your spouse and children under age 18 will receive survivor benefits
Working after retirement If you work (even part-time) after retirement, you
may lose some of your benefits
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The Future of the Social Security System
Will it be around by the time you retire? By 2035, the social security system will be
paying out more than it is taking in Since the program began in 1930s, it has
been ‘fixed’ 42 times ‘Fixes’ usually mean raising taxes or the wage base Suggested changes
Invest some of current surplus in stocks Force workers to save via mandatory retirement
accounts We don’t know what will happen with Social
Security, so plan for your own retirement
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Employer-Sponsored Retirement Plans
Will probably provide bulk of your retirement income Qualified retirement plan – meets certain legal
requirements and offers tax advantages to both employer and employee Defined benefit plans – you are guaranteed a certain
benefit each year Example: pension plan
Defined contribution plan – employer guarantees a yearly contribution while you’re working but doesn’t guarantee a retirement benefit
Example: 401(k) and 403(b) plans Trend is toward these plans and away from defined
benefit plans, but some employers offer both
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Defined Benefit Plan
Many plans are fully funded by employer but others require contribution by employee
Benefits paid based on employee’s income and the number of years employed at company General rule of thumb—multiply number of
years you’ve worked for company by 0.015 times your final salary to estimate your annual pension benefit
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Defined Benefit Plan
Many plans state that if you leave your employer before a certain number of years have passed, will lose all or part of retirement benefits (i.e., you are not vested)
Once you are vested, your benefits upon retirement are guaranteed
Many pension plans are not being adequately funded ERISA attempts to protect employees, but doesn’t
cover state and local government employees
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Key Questions to Ask
About defined benefit plans What are the vesting requirements? What benefits have been credited to your account as of
now Will receive periodic report
What is minimum age for a full pension? Early retirement? Are pension rights protected during leaves of absence,
disability, layoffs? Is the plan fully funded? Does the plan have a COLA adjustment? What death benefits are paid to spouse? How are the pension funds invested? How are individual benefits determined?
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Defined Contribution Plans
AKA money purchase plans, profit-sharing plans, employee stock option plans, savings plans, 401(k) plans, 403(b) plans
Common characteristics Contributions come from both employee and
employer Typically employer matches employee’s contribution up
to certain amount Employee has more control as to how funds are
invested Most plans offer wide range of investment opportunities
Participation may be partly or wholly voluntary
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Defined Contribution Plans
Can reduce your taxes Your taxable income is reduced by the
amount you contribute Example: You pay $2,000 a year into your 401(k)
and you are in the 28% tax bracket Your taxable income is reduced by $2,000 a year,
saving you $560 a year. So, your $2,000 retirement savings only cost $1,440.
You pay taxes on the amount you withdraw once you retire, but not until then
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Defined Contribution Plans
All plans set a maximum contribution up to limit specified by IRS Current limit is $13,000/year or 15% of
income, whichever is lessVesting requirements differ across
employers Typically, your contributions vest
immediately, but several years may pass before employer’s contributions vest
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Defined Contribution Plans
Investment options Many offer numerous mutual funds for you to choose from
Changing jobs If you change jobs, you may receive a lump sum comprised of
Your portion of contributions Your employer’s portion (if vested) Your investment returns
You should roll this amount over into a rollover IRA If you don’t, you may be subject to a 20% withholding tax + penalties
Borrowing money from your retirement plan It’s possible and then you pay the money back to yourself with
interest over a specified time period But, the interest rate you pay yourself may be less than what you
could have earned, and if you leave your job or are laid off, you have only 30 days to repay or you’ll face a tax penalty
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Cash Balance Plans
A defined benefit plan with some of the characteristics of a defined contribution plan
Each employee has a retirement account which is credited every year with both a Pay credit – dependent upon employee’s
salary Interest credit – based on some formula
Can be a variable or a fixed rate
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Cash Balance Plans
Advantages Generally more portable Lump sum depends only on the vested amount
Not on age or length of employment
Disadvantages Employees are not guaranteed a certain
retirement incomeMany experts believe these plans are more
advantageous for younger workers but hurt long-time employees who are in their 50s and early 60s
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Individual Retirement Plans
Many individuals have their own retirement plan—the best known is the IRA
Traditional IRAs Can contribute up to $3,000 ($6,000 total if married—even
if spouse doesn’t work) Ceilings placed on the amount you can deduct (based on
your income) unless you are not covered by a qualified retirement plan, then can deduct full amount (up to the limits specified above)
Even if you can’t deduct IRA contributions, earnings on IRA are still tax deferred
Can contribute to an IRA through 4/15 and still have it count on prior year’s tax return
You control where the money is invested: CDs, bonds, stocks, etc.
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Individual Retirement Accounts
Roth IRAs All earnings are tax deferred Contributions are not tax deductible But, all withdrawals are tax-free Higher income limits
Can make a full contribution as long as your AGI < $150,000/year (married)
With a regular IRA, you can only make a full contribution if you make < $53,000 (married)
Can start using your savings prior to age 59½ Can make tax- and penalty-free withdrawals (if
account has been opened for 5+ years) to purchase first home
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Individual Retirement Accounts
Rollover IRAs Differs from regular IRA in that
You can deposit your rollover funds in a lump sum, regardless of amount, but don’t mix with an existing IRA account
You generally cannot make additional contributions to a rollover IRA
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Individual Retirement Plans
SEP Plans Simplified employee pension plan
For small businesses with < 25 employees Basically specialized IRA
Keogh Plans Pension plan for self-employed people
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Payout Options
Annuity – a series of regular, level, monthly payments, usually for your lifetime
Advantages: security (regular payments, can’t outlive benefits); spouse may get benefits after your death
Disadvantages: may not be indexed for inflation; lack of flexibility; taxes due on annuity every year
Periodic payments – installment payments of roughly equal amount over specified time period
Advantages: security (regular pmts); larger payments than an annuity; may roll some payments into an IRA
Disadvantages: taxes due on the amount received each year (may knock you into an higher bracket); no guarantee of lifetime income; lack of flexibility
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Payout Options
Lump sum – a cash payment of all the money in your account
Advantages: total control over what is done with money; eligible for forward averaging which can reduce your taxes
Disadvantages: taxes due immediately; no guarantee you won’t outlive your financial resources; you may spend money too quickly
IRA rollover – lump-sum payment is deposited into special rollover IRA
Advantages: investments continue to be tax deferred; control over where money is invested; flexibility in timing and amounts withdrawn
Disadvantages: may pay more taxes than if lump sum withdrawal made; MUST begin regular withdrawal at 70½
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Receiving Retirement Benefits
What is best for you may not be what works for someone else
Consult with your benefits office Many offer retirement planning
seminars
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Choosing An Annuity
Very popularMust consider
Rate—is it fixed or variable? Fixed rate offers a fixed payment throughout life of annuity
Sales commission—are you charged a load fee? Withdrawal penalties—are there any, do they decline
over time? Rates and annual fees—comparison shop Financial strength of issuer—annuities are not
federally insured; most are sold by life insurance companies Will only receive your annuity payment if company remains
in business