CHAPTER 14 Retirement Planning: Concepts and Strategies Chapter 14: Retirement Planning1

INTRODUCTION  Americans have relied on the venerable three legged stool to provide for their retirement:  Social Security Benefits  Private Pensions  Personal Savings  Many factors currently threaten the stability of this stool:  Longer Lives  Possible Reduction of Social Security Benefits  Doubtful Viability of Many Corporate Plans  Need for Increased reliance on private resources is the obvious result Chapter 14: Retirement Planning2

INTRODUCTION (Contd.)  In retirement planning:  Individuals first define their goals for quality of life after retirement  Next, they measure their ability to meet their goals, and develop strategies for improving their performance  Finally, success in retirement planning is assured if the individual is able to retire at the desired retirement age with the expected level of income Chapter 14: Retirement Planning3

RETIREMENT BUDGET  Retirement Expenditure Analysis  Analyze client’s current expenditures (Table 14-1 provides example for a hypothetical couple)  Following approaches can be used to arrive at retirement budgets  One approach applies the accepted rule of thumb that a retiree is likely to spend 60% or 70% of the pre- retirement expenditure level  A better approach is to divide fixed and flexible expenditures into several key categories and encourage the client to estimate the retirement expenditure in each category Chapter 14: Retirement Planning4

RETIREMENT BUDGET (Contd.)  Retirement Income  Potential Shortfall  Analytical framework for calculating savings required for retirement is presented in Table  Strategies to solve the potential shortfall problem can be divided into three categories: 1. Tax-Advantaged Investment Planning 2. Savings Planning 3. Asset Repositioning Planning  The Potential Surplus Chapter 14: Retirement Planning5

Retirement Income Needs Analysis Figure 14-1 Retirement Income Needs Analysis Chapter 14: Retirement Planning6

Process  Determine future income need  Determine amount of funds needed to cover income need  Forecast retirement information  1) What do I need to invest to get the amount  2) Given my current program, what return do I need to achieve my goals 7

Determine future income need  Use the 60 – 70% of gross rule (+ or -)  Need to estimate life span; return during retirement; year of retirement  Assume taxes same in retirement as now  DOES THIS SEEM LIKE A FAIR ASSUMPTION??? 8

 CURRENT EARN 75,000 GROSS; AGE 25; RETIRE AT AGE 60; INFLATION 4%; ESTIMATE WILL NEED 75% OF INCOME DURING RETIREMENT 9 AMOUNT NEEDED ANNUALLY TO LIVE DURING RETIREMENT AT SAME LIFESTYLE

Determine amount of funds needed to cover income need  ESTIMATE THAT WILL LIVE TO BE 80 YEARS OLD; INFLATION DURING RETIREMENT 4%. RETURN OF INVESTMENTS 8% 10 Amount needed in retirement accounts to live at desired level Amount needed if we incorporate inflation during retirement years

Forecast retirement information  1) what do I need to invest to get the amount  Currently have $10,000 in my accounts; return will average 10%; Currently invest $500 per month 11 Monthly payment required to achieve goal

Forecast retirement information  2) given my current program, what return do I need to achieve my goals? 12

DISTRIBUTION FROM QUALIFIED PLANS  REQUIRED DISTRIBUTIONS  Minimum Distribution Rules  All qualified plans are required to make minimum distributions when certain rules met  Primary rule : age 70 ½  The RMD is determined by a formula  Essentially divide the account balance by a life expectancy factor  Failure to Make Distributions  50% penalty of the of the amount required and not paid  If should have paid $10K and only paid $4K  Penalty $3K 13

DISTRIBUTION FROM QUALIFIED PLANS (Contd.)  TAXATION OF KEOGH PLANS  There is no lump sum distribution after retirement  Withdrawals must begin by April 1 of the year after a person reaches 70-1/2  Ten-year forward averaging rule also applies to Keogh plans  OTHER TAX CONSIDERATIONS  Premature Distributions  10% penalty  Certain exceptions  Excess Contributions  10% penalty on the excess  Insufficient Distributions  50% penalty on the shortage 14

RETIREMENT INCOME: THE ULTIMATE DECISION  Three principal ways to get your money  Annuity  The Annuity Principle  A major concern is whether we will have enough money to last our lifetime  Insurance companies can guarantee life income payments  Disposition of Proceeds  Variety of methods for payment (life income, period certain, etc)  Tax Treatment of Annuity Payments  Variable Annuity or fixed annuity  The Best Choice? ?  Lump Sum Distribution  Forward Averaging Option  IRA transfer and withdrawals 15

16 Major Sources Of Retirement Income

Forms of Annuities 17

18 Disposition of Annuity Proceeds

RETIREMENT INCOME: THE ULTIMATE DECISION (Contd.) LUMP SUM vs. IRA  It is a taxing decision to choose between a lump sum distribution and an IRA transfer or rollover  Best alternative depends on a host of tax-related factors  Example: John & Betty Jones, both 65, set to retire at year-end  John has the choice of  $2,000 per month for life, or  A lump sum of $250,000  IRA rollover with immediate withdrawals offers the best option  If John lives to age 100, the annuity option is the best 19

RETIREMENT INCOME: THE ULTIMATE DECISION (Contd.)  IRA DISTRIBUTION An individual is free to choose any suitable distribution method, subject to restrictions linked to age 59-1/2 and 70-1/2 Two methods frequently used are:  Systematic Withdrawal: Personal Investment  Systematic Withdrawal: Insurance Plan 20

21 RETIREMENT PLANNING STRATEGIES This section analyzes basic strategies used to accomplish variety of retirement planning objectives LOANS FROM QUALIFIED PLANS – Taking out loan from a qualified plan may be a better alternative than withdrawal, since no tax or penalty is imposed on a loan – However, ultimately taxes may be imposed. Also the plan may withdraw funds from your regular retirement account and place them in a safer investment like a money market as collateral.

RETIREMENT PLANNING STRATEGIES (Contd.)  PLANNING FOR RETIREMENT: ADDITIONAL CONSIDERATION  Early Planning Needed  Should strive to avoid penalty taxes and take advantage of beneficial tax treatments  Minimum Distribution Rules  Everyone’s RMD is calculated based upon Minimum Distribution Incidental Benefit (MDIB) life expectancy factor table  One exception: when spouse is more than ten years younger and is sole beneficiary Chapter 14: Retirement Planning22

RETIREMENT PLANNING STRATEGIES (Contd.)  COMBO STRATEGY Basic Structure: Involves six steps: 1. Estimate client’s monthly budget 2. Determine client’s monthly Social Security income 3. Instruct client’s employer to transfer the lump sum directly from pension plan to an IRA with a money-market mutual fund 4. Calculate shortfall in budget 5. Set up a growth-oriented investment portfolio with desired degree of risk 6. Client should withdraw from this portfolio if and when funds are needed, subject to minimum compulsory distribution at age 70-1/2 Chapter 14: Retirement Planning23

RETIREMENT PLANNING STRATEGIES (Contd.)  COMBO STRATEGY (Contd.)  Concluding Remarks: The Combo Strategy just described is merely one of many options available to a client. Chapter 14: Retirement Planning24