1. Retirement Planning

2. 16-2 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives 1. Understand the changing nature of retirement planning. 2. Set up a retirement plan. 3. Contribute to a tax-favored retirement plan to help fund your retirement.

3. 16-3 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives 4. Choose how your retirement benefits are paid out to you. 5. Put together a retirement plan and effectively monitor it.

4. 16-4 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Introduction Today, you’ve got to come up with retirements funds by yourself. Despite Social Security reform proposals, there might not be Social Security when you retire. Need to know about Social Security, employer-funded pensions, and current retirement plans.

5. 16-5 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Social Security Primary source of retirement income for many senior citizens. Younger workers who won’t retire for another 40 years, Social Security may no longer be there.

6. 16-6 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Financing Social Security FICA taxes paid today are providing benefits for today’s retirees. The money you pay is not being saved up and invested in an account for you. Changes will be necessary, possibly increasing the retirement age or limiting benefits for the wealthy.

7. 16-7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Eligibility 95% of Americans are covered. Pay into system to be eligible and receive credits. In 2008, earned 1 credit for each $1,050 in earnings up to a maximum of 4 credits per year. With 40 credits, eligible for retirement, disability, and survivor benefits.

8. 16-8 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Retirement Benefits Benefits formula—replace 42% of average earnings based on number of earnings years, average level of earnings, adjustments for inflation, income brackets. Full benefits at the “full” retirement age. Reduced benefits at 62 Increased benefits if you delay retirement.

9. 16-9 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 16.1

10. 16-10 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 16.1

11. 16-11 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Disability and Survivor Benefits Provided through mandatory Social Security insurance program. Protection for those with impairment that keeps them from work for at least 1 year. Monthly survivor benefits when breadwinner dies. One-time death benefit for funeral costs.

12. 16-12 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Defined-Benefit Plans Traditional pension plan where you receive “defined” pension payout at retirement. Noncontributory retirement plan Contributory retirement plan

13. 16-13 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Defined-Benefit Plans Portability Vested Funded pension plan Unfunded pension plan

14. 16-14 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Cash-Balance Plans: The Latest Twist in Defined-Benefit Plans Workers are credited with a percentage of their pay each year, plus a predetermined rate of interest. Employers contribute a percentage of your salary each year into an account which grows at 30-year Treasury bond rate. Benefits easier to track and portable.

15. 16-15 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later Step 1: Set Goals How costly a lifestyle will you lead? Do you want to live like a king? Do you have costly medical conditions? Will you relocate or travel? Do you want to live in your own home or retirement community. Decide on the time frame for achieving your goals.

16. 16-16 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 16.2

17. 16-17 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later Step 2: Estimate How Much You Will Need Turn your goals into dollars by estimating how much you will need. Begin with 70-80% of current living expenses to calculate the cost to support yourself in retirement. Don’t forget about paying taxes.

18. 16-18 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 16.2

19. 16-19 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 16.3

20. 16-20 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later Step 3: Estimate Income at Retirement Once you know how much you need, figure out how much you’ll have. Estimate Social Security benefits and determine what your pension will pay.

21. 16-21 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later Step 4: Calculate the (Annual) Inflation- Adjusted Shortfall Compare the retirement income needed with the retirement income you’ll have.

22. 16-22 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later Step 5: Calculate How Much You Need to Cover This Shortfall Know your annual shortfall in your retirement funding. Know how much must be saved by retirement to fund this shortfall.

23. 16-23 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later Step 6: Determine How Much You Must Save Annually Between Now and Retirement Put money away little by little, year by year. Use online retirement planning websites

24. 16-24 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 16.3

25. 16-25 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

26. 16-26 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

27. 16-27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Plan Now, Retire Later What Plan Is Best For You? Most plans are tax-deferred. Contributions can be made on fully or partially tax-deductible basis. Earn compound interest on non-taxed contributions and earnings. Taxed when you withdraw funds.

28. 16-28 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 16.4

29. 16-29 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Defined-Contribution Plan You and employer or your employer alone contributes directly to a retirement account set aside for you. A savings account for retirement.

30. 16-30 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Defined-Contribution Plans Profit-Sharing Plans Money Purchase Plan Thrift and Savings Plan Employee Stock Ownership Plan (ESOP) 401 (k) Plan

31. 16-31 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Defined-Contribution Plans How much can you contribute? Limits on the rise. $15,500 for 401(k) and 403(b) plans in 2008 rises annually by $500 with inflation. “Catch up” of additional $5,000 (also indexed for inflation) for those over 50.

32. 16-32 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Retirement Plans for the Self-Employed and Small Business Employees Keogh Plan or Self-Employed Retirement Plan Simplified Employee Pension Plan (SEP-IRA) Savings Incentive Match Plan for Employees or SIMPLE plan

33. 16-33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Individual Retirement Arrangements (IRAs) Traditional IRA Roth IRA Coverdell Education Savings Account (known as Education IRA)

34. 16-34 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Traditional IRAs Tax advantaged—contribution may or may not be tax-deductible depending on individual’s level of income and whether he/she, or spouse, is covered by a company retirement plan. Restrictions on timing and amount of withdrawals but can rollover a distribution. Saver’s tax credit

35. 16-35 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall The Roth IRA Contributions are not tax deductible but made out of after-tax income. Money grows tax free and withdrawals are tax free. No withdrawal restrictions or tax penalty like traditional IRA but can also rollover.

36. 16-36 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Traditional Versus Roth IRA: Which is Best for You? You end up with the same amount to spend at retirement, if both are taxed at the same rate. Choose the Roth IRA if you can pay your taxes ahead of time.

37. 16-37 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Saving for College: The Coverdell Education Savings Accounts (ESA) Works like a Roth IRA, except contributions are limited to $2000 annually per child under 18. Income limits begin at $95,000 for singles, and $190,000 for couples. Earnings are tax-free and no taxes on withdrawals to pay for education.

38. 16-38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Saving for College: 529 Plans Tax-advantaged savings plan used for college and graduate school. Contribute up to $250,000, grows tax-free. Plans are sponsored by individual states, open to all applicants regardless of where they reside. Invest directly or through financial advisor.

39. 16-39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Facing Retirement—The Payout Plan ahead before you decide how you receive a payout. Look at all your retirement plan payouts together—may want some in lump sum, others as annuity. Use diversification and time dimension of risk when deciding what to do with funds.

40. 16-40 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall An Annuity, or Lifetime Payments Single Life Annuity An Annuity for Life or a “Certain Period” Joint and Survivor Annuity A Lump-Sum Payment

41. 16-41 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 16.4

42. 16-42 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tax Treatment of Distributions Annuity payouts are generally taxed as normal income. Can pay all taxes at one with lump sum or have the distribution “rolled over” into an IRA or other qualified plan. With rollover can avoid paying taxes on the distribution while the funds continue to grow on a tax-deferred basis.

43. 16-43 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Putting a Plan Together and Monitoring It Most people rely on retirement savings from a combination of different plans. Start with seven steps. Invest maximum allowed in tax-sheltered plans according to your investment time horizon. Monitor before and after retirement.

44. 16-44 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 16.5

45. 16-45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Saving for Retirement—Let’s Postpone Starting for One Year One year delay can cost you a lot—almost $150,000. Only end up with more when you begin saving for retirement earlier.

46. 16-46 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 16.6

47. 16-47 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Summary Social Security benefits are determined by number of years of earnings, the average level of earning, an adjustment for inflation. Funding retirement needs follows a seven- step process from setting goals to putting the plan in place and saving.

48. 16-48 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Summary Tax-favored retirement plans can be employer-sponsored, for self-employed, or individual retirement accounts—where contributions and earnings are not taxed. Retirement benefits can be received as a lump sum, annuity, or combination. Monitor retirement saving before and after you retire for new, unexpected changes.