PFIN 14 Planning for Retirement 5 BILLINGSLEY/ GITMAN/ JOEHNK Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

LEARNING OUTCOMES Recognize the importance of retirement planning, and identify the three biggest pitfalls to good planning Estimate your income needs in retirement and the level of retirement income you’ve estimated from various sources Explain the eligibility requirements and benefits of the Social Security program PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Describe the various types of self-directed retirement plans LEARNING OUTCOMES (continued) Differentiate among the types of basic and supplemental employer-sponsored pension plans Describe the various types of self-directed retirement plans Choose the right type of annuity for your retirement plan PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Steps in Retirement Planning Describe: Things a person wants to do in retirement Standard of living that is hoped to be maintained Level of income wished to receive Retirement goals PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Role of Retirement Planning Formulating an investment program Creating a savings plan in which a certain amount of money is saved each year Identifying the investment vehicles that will meet the retirement needs Tax planning Maximizes the accumulation of retirement funds PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Pitfalls in Retirement Planning Starting too late Saving less Investing conservatively PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Estimating Income Needs Strategies for forecasting retirement needs Plan for retirement over a series of short-run time frames State retirement income objectives as a percentage of the present earnings Follow a long-term approach Formulate the level of income expected to receive Identify the required amount of funds needed to achieve a desired standard of living PFIN5 | CH13 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Exhibit 14.1 Sources of Income for the Average Retiree Source: Federal Interagency Forum on Aging-Related Statistics, Older Americans 2012: Key Indicators of Well-Being, Indicator 9, June 2012, p. 14, http://www aoa.gov/Agingstatsdotnet/Main_Site/Default.aspx, accessed November 2015. PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Social Security Coverage Classes of employees exempted Federal civilian employees hired before 1984 and are covered under the Civil Service Retirement System Employees of state and local governments who have chosen not to be covered Marginal employment positions Newspaper carriers under age 18 and full-time college students working for a university PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Social Security Payroll Taxes Cash benefits provided are derived from the payroll (FICA) taxes paid Tax rate in 2014 6.2 percent for Social Security 1.45 percent for Medicare PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Received by fully covered workers Old-Age Benefits Received by fully covered workers Full retirement age as defined by the Social Security Administration is 67 years Ways of receiving in a two-income family Take the full benefits to which each is entitled from his or her account Take the husband and wife benefits of the higher-paid spouse PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Received by the spouse if a covered worker dies Survivor’s Benefits Received by the spouse if a covered worker dies Small lump-sum payment of several hundred dollars, followed by monthly benefit checks Eligibility criteria Surviving spouse must be at least 60 years of age Having a dependent and unmarried child of the deceased worker in his or her care PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Much Are Monthly Social Security Benefits? Social Security Administration’s computerized service estimates the benefits Social Security Statement provides credit information under the scenarios Retirement at age 62 and receive 70 percent to 80 percent of the full benefit Full benefit at age 65 to 67 Increased benefit available if the retirement is delayed until age 70 PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Exhibit 14.2 Average Monthly Social Security Benefits Paid in 2014 Source: “Understanding the Benefits,” SSA Publication No. 05-10024, ICN 454930, http://www.socialsecurity.gov/pubs/EN-05-10024.pdf#page51&zoom5auto,0,576, accessed November 2014. PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Much Are Monthly Social Security Benefits? Taxes on benefits Applicable if the beneficiary’s annual income exceeds: $25,000 for a single taxpayer $32,000 for married taxpayers filing jointly Zero for married taxpayers filing separately PFIN5| CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Pension Plans and Retirement Programs Employee Retirement Income Security Act of 1974 (ERISA) Ensures that workers eligible for pensions actually receive benefits Permits uncovered workers to establish individual tax-sheltered retirement plans PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Types of Employer-Sponsored Retirement Programs Basic plans Employees automatically participate after a certain period of employment Supplemental plans Voluntary programs Enable employees to increase the amount of funds being set aside for retirement PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Participation requirements Basic Plans Participation requirements Eligibility criteria Years of service Minimum age Level of earnings Employment classification Vested rights: Employees’ nonforfeitable rights to receive benefits in a pension plan PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Employee contribution Basic Plans Employee contribution Noncontributory pension plan: Employer pays the total cost of the benefits Contributory pension plan: Employee bears part of the cost of the benefits Defined contribution Specifies the contributions that both employer and employee must make PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Basic Plans Defined benefit Qualified pension Involves formula for computing benefits is stipulated in its provisions Qualified pension Meets specified criteria established by the Internal Revenue Code PFIN5| CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Types of Supplemental Plans Employees of a firm participate in the company’s earnings Profit-sharing Supplements pension and other fringe benefits Firm contributes an amount equal to a set proportion of the employee’s contribution Thrift and savings Agreement by which part of a covered employee’s pay is withheld and invested Salary reduction or 401(k) PFIN5| CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Features Used to Evaluate Employer-Sponsored Pension Plans Eligibility requirements Defined benefits or contributions Vesting procedures Contributory or noncontributory Retirement age Portability Voluntary supplemental programs PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Self-Directed Retirement Programs Keogh plan Account to which self-employed persons may make specified payments that are deducted from taxable income Earnings also accrue on a tax-deferred basis SEP plan Aims at small business owners, requiring a plan which is simple and easy to administer PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Self-Directed Retirement Programs Individual retirement account (IRA) Open to any working American Person may contribute a specified amount each year Types Traditional (deductible) Nondeductible (after-tax) Roth PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Investment product created by life insurance companies Annuity Investment product created by life insurance companies Provides a series of payments over time Accumulation period: Premiums are paid for the purchase of an annuity Distribution period: Annuity payments are made to an annuitant Survivorship benefits: Portion of premiums and interest unreturned to the annuitant before his or her death PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Classification of Annuities Purchased with a lump-sum payment Single premium Annuitant begins receiving monthly benefits immediately Immediate Purchased through periodic payments made over time Installment premium Payments are postponed for a certain number of years Deferred benefit PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Disposition of Proceeds Annuitant receives a specified amount of income for life, regardless of the length of the distribution period Life annuity with no refund Provides a guaranteed minimum distribution of benefits Life annuity, period certain Refund annuity Guaranteed-minimum annuity Provides a specified monthly income for a stated number of years without consideration of any life contingency Annuity certain PFIN5| CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Fixed versus Variable Annuity Fixed-rate annuity Insurance company agrees to pay a guaranteed rate of interest on the money Variable annuity Monthly income provided by the policy varies as a function of the insurer’s actual investment experience PFIN4 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

KEY TERMS Profit sharing plan Employee Retirement Income Security Act of 1974 (ERISA) Vested rights Noncontributory pension plan Contributory pension plan Defined contribution plan Defined benefit plan Qualified pension plan Profit sharing plan Thrift and savings plan Salary reduction or 401 (k) plan Keogh plan Individual retirement account (IRA) Annuity Accumulation period Distribution period Survivorship benefit PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

KEY TERMS Fixed-rate annuity Single premium annuity contracts Deferred annuity Life annuity with no refund (pure life) Guaranteed-minimum annuity (life annuity with refund) Life annuity, period certain Refund annuity Annuity certain Fixed-rate annuity Variable annuity PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

SUMMARY The pitfalls to good planning are starting too late, saving less and investing conservatively The sources of retirement income are Social Security, earnings from income producing assets, earnings from full and part time jobs, and pension plans Social Security provides old-age and survivor benefits to retired people and their dependents PFIN5| CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Employer-sponsored retirement programs SUMMARY Employer-sponsored retirement programs Basic plans - Employees automatically participate after a certain period of employment Supplemental plans are voluntary programs Self directed retirement programs include Keogh plan, SEP plans and IRAs Annuities are classified based on payment of premiums, disposition of proceeds, inception date of benefits, and methods used in calculating benefits PFIN5 | CH14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.