The Retirement Issue The Retirement Issue www.fcef.com.

The Retirement Issue The Retirement Issue

Principles Discussed Time Value of Money
Individual Retirement Account (IRA) Traditional Roth Simplified Employee Pension (SEP) Savings Incentive Match Plans for Employees (SIMPLE) 401(k) and 403(b) Roth 401(k) and Roth 403(b) Annuities The Retirement Issue

Time Value of Money Input Rate of Return Time
There are three elements or components that affect the growth of your money. Input, rate of return, and time, Which has the greatest potential impact? Which do you have the most control over? Time! You get to pick the date you start saving and investing. The sooner you start, the more time your money has to grow! The Retirement Issue

Starting Early $248,855 Age Return 25 Begin Investing 30 $22,968 35
$59,959 40 $119,533 45 $215,478 50 $369,998 55 $618,853 $248,855 Average Annual Return 10% Cumulative Return % Age Return 25 30 Begin Investing 35 $22,968 40 $59,959 45 $119,533 50 $215,478 55 $369,998 Person A gets started early, setting aside $300 a month over thirty years. In that time, she will invest $108,000. Conversely, laid-back Person B keeps intending to start investing but doesn’t actually get around to it until Person A has a five-year head start. In 25 years, he will have invested $90,000. Since they’re both investing for what seems like a pretty distant retirement goal, Person B figures that five years isn’t going to make a big difference. Big mistake—because even though he will invest only $18,000 less than Person A, $90,000 versus $108,000, the difference in return is substantial, almost a quarter of a million dollars! Note: This hypothetical example excludes sales charges and expenses, and it does not represent the past or future performance of any particular investment and is used for illustrative purposes only. Rate of return cannot be guaranteed for any equity investment. Average Annual Return 10% Cumulative Return 974.90% The Retirement Issue

Saving and Retirement Accounts
Savings Accounts Cash for emergencies and short-term goals Liquid asset with no penalty for withdrawal Retirement Accounts Long-term investment for retirement years Some funded with pretax dollars Tax-deferred or tax-free growth Withdrawals prior to age 59 ½ usually entail additional taxes There are different ways for your money to work for you. A savings account is great for setting money aside for emergencies and short-term goals. It is a liquid asset, which means it is readily available for use, with no withdrawal penalty. Generally speaking, savings accounts have low interest rates, usually less than 2 or 3%, which means your input grows slowly. A retirement account offers tax advantages to encourage you to invest over the long term for a comfortable retirement. Some accounts are funded by pretax dollars, and all have tax-deferred growth, which means the earnings on your investment are not taxed until withdrawal. Withdrawals prior to age 59½ usually result in tax and additional tax penalties. Hopefully you already have a savings account for emergencies, a car, your graduation trip, or other expenses. A savings account serves a different purpose than a retirement account, which is designed to work and grow for you until you use it for living your retirement years on your terms! The Retirement Issue

Traditional IRA Set up with a custodian
Variety of savings and investment vehicles Funded from post-tax income Depending on income, contributions may be tax-deductible Growth is tax-deferred A Traditional IRA provides tax advantages for setting aside dollars for retirement. The IRA must be set up with a custodian, which can be a bank or credit union, savings and loan association, insurance company, mutual fund, or investment broker. IRAs are offered in a variety of savings and investment vehicles, such as money market accounts, certificates of deposit (CDs), stocks, bonds, and mutual funds. The money going into your Traditional IRA usually comes from post-tax dollars. If you have the funds deposited from your paycheck, the money is deducted from your net income after taxes have been taken from your gross income. Depending on your gross income, you may be eligible to deduct all or part of your Traditional IRA contributions for the year. Tax-deferred growth. Taxes are paid only when you withdraw assets. Taxable assets include any earnings in the account and any contributions deducted from gross income. The Retirement Issue

Contributions Withdrawals
Limit of $5000 if under age 50 Limit $6000 if 50 and over Tax refund can be direct-deposited into IRA Can continue until age 70½ Reportable and taxable Withdrawals prior to age 59½ may result in taxation and early withdrawal penalties No penalty after 59½ Early Distribution 10% additional tax Exceptions The maximum contribution limits change from year to year. The current limit is $5,000 for anyone under age 50, and folks aged 50 and over can contribute an extra $1000 per year if that person has attained age 50 by the end of the tax year—for most people this is December 31. Last year’s tax refund, which you will receive this year, can be direct-deposited into an IRA for last year. It’s important to know that this does not change the April 15 deadline for IRA contributions, so if you choose to do this, you must file your return early! You can continue to contribute to your Traditional IRA as long as you have taxable income for the year in which you contributed; however, all contributions to a Traditional IRA must stop once the participant reaches age 70½. Withdrawals from Traditional IRAs are reportable and taxable. You can withdraw assets from a Traditional IRA without additional tax once you have reached age 59½. A withdrawal prior to age 59½ is called an early distribution, which may be subject to a 10% additional tax. There are certain exceptions to this general rule. Some exceptions are: First time homebuyer. Disability. Death of the owner—the beneficiary can withdraw. Unreimbursed medical expenses over a certain percentage of income. Higher education expenses equal to or greater than the withdrawal. Distributions prior to age 59½ in the form of an annuity that continues for at least five years or until the participant reaches age 59½, whichever is later. The Retirement Issue

Required Minimum Distribution
Withdrawals from Traditional IRA are required beginning at age 70½ No later than April of the year following the year that the owner reaches age 70½ IRA distributions can go to charity and not be reported as income If you are the owner of a Traditional IRA, you must start taking withdrawals from your IRA no later than April 1 of the year following the year in which you reached age 70½. For example, if you turn 70½ in 2011, you must receive your first minimum required distribution no later than April 1, 2012. The Pension Protection Act allows taxpayers to donate money to charities directly from their IRA account. Taxpayers are allowed to donate up to $100,000 per year from their IRA. Since the distribution will not be included in taxable income, individuals will not be able to claim a tax deduction for the charitable contribution. The Retirement Issue

Roth IRA Set up with a custodian
Variety of savings and investment vehicles Funded from post-tax income Growth is tax-free A Roth IRA provides tax advantages for setting aside dollars for retirement. The Roth must be set up with a custodian, which can be a bank or credit union, savings and loan association, insurance company, mutual fund, or investment broker. Roth IRAs are offered in a variety of savings and investment vehicles, such as money market accounts, certificates of deposit (CDs), stocks, bonds, and mutual funds. A Roth IRA is funded from post-tax dollars. The growth of a Roth IRA is tax-free. The Retirement Issue

Contribution limit is $5,000 Income level affects eligibility to contribute No age limitations for contributing Withdrawals are always reportable, not always taxable Withdrawals are tax-free Distributions can go to charity and not be reported as income No minimum required distributions at age 70½ The maximum contribution limits change from year to year. The current limit is $5,000 for anyone under age 50, and folks aged 50 and over can contribute an extra $1000 per year. This applies if that person has attained age 50 by the end of the tax year—for most people this is December 31. There are certain income limits that affect a person’s specific eligibility to contribute to a Roth IRA. There are no age limitations. Unlike a Traditional IRA, participants can continue to contribute to a Roth IRA past the age of 70½, as long as they have taxable income for the year in which they contribute. A taxpayer’s tax refund received in the following year can be direct-deposited into an IRA for the prior year. It’s important to know that this does not change the April 15 deadline for IRA contributions, so the tax return must be filed early! Withdrawals from Roth IRAs are always reportable, but they are not always taxable. If you have held the Roth IRA for a minimum of 5 years, you can withdraw the principal amount from the Roth IRA prior to age 59½ without taxes or penalties for disability, to buy a first home, etc. You can withdraw assets without penalty from a Roth IRA once you have reached age 59½ and have owned the account for at least 5 years. Withdrawals that take place before both of these conditions are met may need to be included in gross income and may face an additional 10% tax. The Pension Protection Act of 2006 allows taxpayers to donate money to charity directly from their IRA account. Taxpayers are allowed to donate up to $100,000 per year from their IRA. Since the distribution will not be included in taxable income, individuals will not be able to claim a tax deduction for the charitable contribution. Unlike Traditional IRA accounts, there are no requirements to start liquidating the Roth IRA account at age 70½. If you intend to take funds from any IRA account check IRS Publication 590, Individual Retirement Arrangements (IRAs), available on the IRS website, for additional information on taxes and penalties that may apply to your withdrawal. The Retirement Issue

SEP- Simplified Employee Pension Plan
Employer-sponsored retirement plan Small businesses Self-employed individuals Growth is tax-deferred A Simplified Employee Pension (SEP) Plan is an employer-sponsored retirement plan for small businesses and self-employed individuals. The growth is tax-deferred, and taxes are paid when the assets are withdrawn. The Retirement Issue

Employer makes voluntary contributions Amount may vary each year All eligible employees receive same percentage of compensation Employer may be able to deduct contribution amount from taxes Withdrawals are reportable and taxable Withdrawals prior to age 59½ may be subject to additional tax The employer makes voluntary contributions to the employee’s account. Contributions can vary each year, and all eligible employees receive the same percentage of compensation. The employer making the contributions to the SEP may be eligible to deduct the amount from his or her taxes. Withdrawals from SEP IRAs are reportable and taxable. You can withdraw assets from a SEP IRA without additional tax once you have reached age 59½. The Retirement Issue

SIMPLE Savings Incentive Match Plan for Employees
Employer-sponsored retirement plan Can be a SIMPLE IRA Growth is tax-deferred Two contribution options A SIMPLE, or Savings Incentive Match Plan for Employees, is an employer-sponsored retirement plan that allows employees to contribute a given amount of their annual income through an income deferral plan. The rules governing them are based on the SIMPLE plan, rather than on the rules for traditional or Roth IRAs. The growth is tax-deferred, and taxes are paid when the assets are withdrawn. The Retirement Issue

Option 1 Employee makes voluntary contribution through income deferral Employer is required to match employee’s contribution up to 3% of employee’s annual compensation Option 2 Employer contributes 3% to all employee plans, regardless of level of employee participation Withdrawals are reportable and taxable Withdrawals prior to age 59 ½ may be subject to additional tax Contributions: Employees may elect to participate or not participate. SIMPLE IRAs currently allow up to $11,500 of an employee’s annual income to be contributed. The employer is required to match each participating employee’s contribution up to 3% of annual compensation. Alternatively, the employer may elect to contribute up to 3% to all employee plans regardless of the employees’ level of participation. Withdrawals from SIMPLE IRAs are reportable and taxable. You can withdraw assets without additional tax once you have reached age 59½. The Retirement Issue

401[k] Employer-Sponsored Retirement Plan Funded from pretax dollars
Funds and growth are tax-deferred A 401(k) is an employer-sponsored retirement plan that many companies offer their employees. The Retirement Issue

Employees choose from a list of funds which to contribute to and how much goes to each Employees can use payroll deduction to contribute pretax dollars Employer can match contributions or contribute a specified amount to employee’s fund Employer can contribute even if employee doesn’t Withdrawals are allowed in cases of Termination Disability Death Hardship, if allowed by company Cash withdrawals subject to 20% additional tax Withdrawal may be rolled over to another tax-qualified plan Contributions: Usually, employees choose from a list of funds which to contribute to and how much to contribute to each fund. Employees can contribute pretax dollars through payroll deduction. The amount an employee contributes to the 401(k) from pretax dollars lowers taxable income. For example, if an employee is paid $1000, but contributes $100 to a 401(k), only $900 will be subject to income tax. The employer may match employee contributions up to the limits specified and/or contribute money to the employee’s fund. Also, the employer may contribute to the employee’s account, even if the employee doesn’t. Withdrawals: Like an IRA, the invested amount and growth are not taxed until the funds are withdrawn. Withdrawals are allowed in cases of termination, death, disability, or if the company allows it, upon hardship. A 20% additional tax is usually applied to any 401(k) dollars taken directly in cash at the time of retirement or termination. To avoid this penalty, the dollars can be directly rolled over into another tax-qualified plan. The Retirement Issue

403[b] Defined contribution plan for investments for employees of
Non-profit organizations Hospitals Public schools Universities Very similar to 401(k) in features and restrictions Funded from pretax dollars Funds and growth are tax-deferred The 403(b) is an investment plan for employees of non-profit organizations, hospitals, public schools, and universities. 403(b)s and 401(k)s are very similar in features and restrictions. Like the 401(k) plan, it was designed to enable workers to accumulate funds for retirement in long-term, income tax-deferred investment accounts. The Retirement Issue

Employees choose from a list of funds which to contribute to and how much goes to each Employees can contribute pretax dollars through payroll deduction Employer can match contributions up to specified limits or contribute money to employee’s fund Employer can contribute even if employee doesn’t Withdrawals are allowed in cases of Termination Disability Death Hardship, if allowed by company Cash withdrawals subject to 20% additional tax Withdrawal may be rolled over to another tax-qualified plan Contributions: Usually, employees are provided a list of funds in which they may invest. From that list employees can select which fund(s) to contribute to and how much to contribute to each fund. Employees can contribute pretax dollars through payroll deduction. The amount an employee contributes to the 403(b) from pretax dollars lowers taxable income. For example, if an employee is paid $1000, but contributes $100 to a 403(b), only $900 will be subject to income tax. The employer may match employee contributions up to the limits specified and/or contribute money to the employee’s fund. Also, the employer may contribute to the employee’s account, even if the employee doesn’t. Withdrawals: Like the 401(k), the invest amount and growth are not taxed until the funds are withdrawn. Withdrawals are allowed in cases of termination, death, disability, or if the company allows it, upon hardship. A 20% additional tax usually applies to any 403(b) dollars taken directly in cash at the time of retirement or termination. To avoid this penalty, the dollars can be directly rolled over into another tax-qualified plan. The Retirement Issue

Roth 401[k] & Roth 403[b] Growth is tax-free
Certain criteria must be met Beginning January 1, 2006, plan sponsors of 401(k) and 403(b) plans could offer a Roth feature for employee salary deferrals. The growth of a Roth 401(k) or Roth 403(b) is tax-free, which means you will not have to pay income taxes upon withdrawal as long as certain criteria are met. The Retirement Issue

Allowed in cases of Termination Disability Death Hardship, if allowed by company Cash withdrawals may be subject to 20% additional tax May be rolled over to another tax-qualified plan Tax-free under certain conditions. Required minimum distributions apply Participant can make retirement contributions On a pretax basis to traditional account On a post-tax basis to Roth account A combination of the two Contributions are irrevocable and cannot be shifted to a pretax account Contributions: If the Roth is offered, participants have the option of making plan contributions in three different ways: Pretax basis to a traditional 401(k) Roth basis (post-tax) to a Roth 401(k) A combination of the two Only employee-elective deferrals are available for Roth treatment; all employer contributions to qualified plans will remain pretax. It is important to remember that contributions to a Roth 401(k) or 403(b) will not lower your taxable income as a conventional 401(k) or403(b) contribution will. Contributions are irrevocable once they are in a Roth 401(k) or 403(b), and they cannot be shifted to a pretax account. Any employer contribution will continue to be made into the pretax 401(k)/403(b) account. Roth 401(k) and 403(b) accounts have higher annual contribution limits than Roth IRAs and no income limits. Withdrawals: The plan rules that govern withdrawals from regular 401(k) and 403(b) plans will also apply for Roth 401(k) and 403(b)s. Withdrawals are allowed in cases of termination, death, disability, or if the company allows it, upon hardship. Cash withdrawals prior to age 59½ may be subject to a 20% additional tax. When you leave your company or retire, the Roth portion of your 401(k) or 403(b) could be rolled over directly to a Roth IRA where it would continue to grow tax-free. For a withdrawal to remain tax-free, the account would have to be held for 5 years and the account owner would have to have reached 59½ years of age. Upon reaching age 70½, you must start taking withdrawals from your Roth 401(k) or 403(b) no later than April 1 of the year following the year in which you reached age 70½. The Retirement Issue

Annuities Investment vehicle combined with insurance contract
Designed to provide income for a given time or for the life of the annuitant Growth is tax-deferred Two types An annuity may become an important part of your retirement savings plan. Annuities combine an investment vehicle with an insurance contract. The purpose of the insurance contract is to protect the designated beneficiary against loss of capital, but it also enables the investment to grow tax-deferred. One drawback is that most of the assets cannot be accessed before age 59½ without a 10% additional tax. Also, capital gains are taxed as ordinary income when distributions begin. The purpose of the annuity contract is to create an invested pool of money to provide a series of payments—an income stream—to the person named as the annuitant in the contract. Payments—usually monthly—may be for a designated period of time or for the life of the annuitant. There are several “persons” named in an annuity contract: the owner, the annuitant, and a designated beneficiary. In most cases, the owner and the annuitant are the same. The beneficiary is the person designated to receive the proceeds of the contract, if there are any, following the death of the annuitant. The two major types of annuities are deferred and immediate. The Retirement Issue

Deferred Annuity Provides income at later date at least a year after purchase Two phases Accumulation—series of payments into account Distribution—payments out of account Fixed or variable Fixed—pays fixed interest rate guaranteed by issuer; payments based on set formula Variable—no fixed interest rate; payments based on performance of securities; investor assumes risk and potential for greater growth A deferred annuity provides income at some later date, at least a year away. There are two phases to a deferred annuity: the accumulation phase, in which the owner makes investments, or payments, into the annuity; and the distribution phase, in which the annuitant receives income. A fixed annuity pays a fixed interest rate which is guaranteed by the issuer—the insurance company. The payments to the annuitant are based on a set formula. This category has lower risk than the variable annuity because the risk is assumed by the insurance company. A fixed annuity may be immediate or deferred. A fixed annuity might be appropriate for a person who wants a guaranteed monthly income and is risk averse or simply concerned about outliving his or her assets—for example, a retired person who has already accumulated assets. A variable annuity is only offered as a deferred type of annuity. This category does not have a fixed interest rate. Premium payments are generally invested in a separate account similar to a mutual fund. The payments to the annuitant are based on the performance of securities held in the separate accounts. There is market risk with variable annuities, but there is also the potential for greater growth. The investor assumes the risk in this type of annuity. A variable annuity would be more appropriate for someone who is interested in accumulating assets for the longer term and is able to handle the risk. An easy way to remember the difference between fixed and variable annuities may be to compare them with CDs and mutual funds. A fixed annuity, with low risk and a guaranteed interest rate, is similar to a CD, while a variable annuity, with higher risk and a higher potential return, is more like a mutual fund. Neither fixed nor variable is inherently better than the other. Each has purposes for which it will be appropriate. The Retirement Issue

Immediate Annuity Purchased with single, lump-sum payment
No accumulation phase; distribution begins immediately Only available as fixed annuity An immediate annuity is purchased with a single, lump-sum payment and provides income immediately or within one year following purchase. In an immediate annuity, there is no accumulation phase. The distribution phase starts immediately. It must be a fixed annuity. The Retirement Issue

Cancellation or Exchange
Owner has option to cancel an annuity any time before distribution begins There may be a termination penalty Assets, minus any penalty, returned to owner Exchange Owner has option to exchange the original annuity for another at a different issuing company with no tax consequences Known as a 1035 exchange As long as the owner is alive, he or she has the option to cancel the annuity contract at any time before the annuity period—the beginning of the distribution phase. The issuer may impose a termination penalty. Upon cancellation, the assets of the annuity, minus any penalties, will be returned to the owner. The owner also has the option to exchange the original annuity for another annuity, without tax consequences, at a different issuing company. This type of exchange is known as a 1035 exchange. The Retirement Issue

Annuity Withdrawals Can be made during accumulation phase
10-20% of assets available annually Withdrawal charge may apply Taxes and penalties may apply May be treated as asset reduction or loan Provisions specific to contract Withdrawals can be made from an annuity during the accumulation period. Annuity contracts generally allow withdrawals of 10 to 20 percent of the assets annually. Withdrawals may be subject to a withdrawal charge, depending on how long the assets have been in the annuity. Since withdrawals are made on a last in-first out basis for income tax purposes, the first amounts withdrawn are usually earnings on which taxes and penalties, for withdrawals before age 59½, are due. Withdrawals may be treated as a reduction of assets or as a loan requiring repayment and interest. Details on the use of this option may vary from one annuity contract to another. The Retirement Issue

Advantages Disadvantages
No contribution limit Tax-deferred growth Potential for lifelong income Investment flexibility (variable annuity) Insured investment (variable annuity) Withdrawals & distribution treated as ordinary income for tax purposes No residual estate Penalty for early withdrawal Expenses No “stepped-up” cost basis for beneficiaries Advantages: No limit to contributions. Tax deferral on earnings until withdrawal. Potential for lifelong income. If you select the proper provisions upon annuity or payout phase, the annuity will provide a lifelong stream of income. Investment flexibility—for variable annuities. Most variable annuities offer a variety of investment options, which vary in risk level and potential growth. Assets can be exchanged among these options without tax consequences. Insured investment—for variable annuities. In a variable annuity, the issuer will assure that if death occurs during the accumulation phase, the beneficiary will receive at least the amount that was paid in, minus previous withdrawals. Some variable contracts also guarantee a minimum rate of return on the assets in this event. Disadvantages: No capital gains tax advantage. When withdrawals are made, the earnings are treated as ordinary income for tax purposes, without preferential treatment for capital gains. In an ordinary mutual fund, capital gains are taxed at a lower rate than regular income. For those in a higher tax bracket, the tax costs can be significant. No residual estate. If the annuitant dies after the distribution phase has started, no residual payments will be made to his or her estate, regardless of the value of the account. Some annuity options will provide continuing income to the survivors. Penalty for early withdrawal. If withdrawals are made before age 59½, the earnings portion of the withdrawal is subject to a 10% additional tax—premature distribution penalty—as well as federal income taxes. The penalty may not be incurred in the case of death, disability, certain medical expenses, or periodic payments that continue at least 5 years or until age 59½. Expenses. Annuities often come with a hefty price tag. A person who is considering using an annuity to save for retirement should compare the cost and advantages against the other options available, such as IRAs, retirement benefits offered by employers, and ordinary mutual fund accounts. No “stepped up” cost basis for beneficiaries. The beneficiary’s cost basis—the amount from which capital gains and losses are calculated for tax purposes—is the same as the account owner’s. When the beneficiary begins receiving distributions from the annuity, he or she will have to pay income taxes on any growth in the annuity that has occurred since it was purchased. This is also true for most tax-qualified plans. In most non-tax-qualified accounts, the cost basis is “stepped up” to the market value at the time of the owner’s death. This means the beneficiary will only have to pay taxes on any appreciation that occurs after the owner’s death. The Retirement Issue

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