1. Chapter 18

2. Learning Objectives (1 of 2) Define the characteristics of a tax- favored savings program Explain the key features of the different IRA programs Compare a Roth vs. a traditional IRA Describe Keogh, 403(b), and 401(k) programs

3. Learning Objectives (2 of 2) Describe an annuity Explain an annuity’s payout options Distinguish between a fixed rate and variable rate annuity Choose among various annuity proposals Construct a retirement plan

4. Characteristics of a Tax- Favored Savings Program Have at least one or two of the following features, but not all three: Tax deductible contributions Tax deferral of income Partial or complete tax exemption of withdrawals

5. The IRA Programs (1 of 4) (Traditional) IRA Maximum contribution for 2002 ($3,000 but $3,500 if age 50 or older) Contribution an adjustment to gross income if AGI less than specified maximum May always make a non-deductible contribution Must start withdrawals between ages 59 ½ and 70 ½

6. The IRA Programs (2 of 4) Spousal IRA As long as combined income on a joint return exceeds the combined IRA contributions of both spouses, a non- working (or low-income) spouse may also set up an IRA

7. The IRA Programs (3 of 4) Educational IRA Contributions are NOT deductible No contributions by people with AGI over specified maximum In 2002, maximum contribution per child is $2,000 Withdrawals are fully tax exempt if used to pay for educational expenses

8. Educational IRA (4 of 4) Roth IRA Maximum contribution of $3,000 in 2002 No contributions by people with AGI over specified maximum All withdrawals tax free if in account for at least 5 years and recipient over age 59 ½ No minimum required withdrawals (as is the case with a traditional IRA)

9. Comparison of Roth & Traditional IRAs A Roth contribution is always better than a nondeductible IRA contribution A comparison of a deductible IRA with a Roth IRA depends on how one’s current marginal tax rate (MTR) compares with one’s MTR at retirement If higher now, choose deductible IRA If lower now, choose Roth IRA

10. Keogh Plans Officially known as HR 10 plans For self-employed or small companies Similar to a traditional deductible IRA account May be either a profit-sharing plan or a money purchase plan

11. 401(k)s and 403(b)s Both typically function as defined contribution plans 401(k)s are available to for-profit businesses 403(b)s are available to not-for-profit operations

12. Annuities A steady stream of consecutive payments Four broad categories of annuities SPDA's (Single Premium Deferred Annuities). A qualified SPDA would be ideal for an individual taking money from a pension plan, IRA, 401(k) or other tax deferred savings program. FPDA's (Flexible Premium Deferred Annuities). A nonqualified FPDA would be a form of a savings program for retirement. FPDA's allow you to contribute on a monthly basis.

13. Annuities (cont.) CD-type annuities. These are similar to SPDA's, but have guaranteed rates over selected periods of time. Number of payments is exactly defined. SPIA's (Single Premium Immediate Annuity). Similar to a SPDA, except that the benefit payments begin upon receipt of the single premium.

14. Payout Options for an Annuity Cash Refund Option: Any cash value in policy is paid to a contingent payee when annuitant dies Installment Refund Option: cash value will be paid in installments when annuitant dies Life with Period Certain:a minimum number of payments guaranteed (usually 5, 10, 15, or 20 years)

15. Payout Options (cont.) Life or Straight Life Option: All benefits lost when annuitant dies (highest risk to buyer, but highest payout) Joint and Survivor Option: sold to couples, reduction in payment when first person dies. May be combined with the other payout options

16. Fixed vs. variable rate annuity Must choose for accumulation period (if any), and for payout period Variable rate policies are tied to some investment (such as a stock mutual fund) Many people make part of policy fixed rate and part variable rate

17. Choosing an annuity policy Make sure company issuing policy is considered financially sound For an immediate annuity, look for who gives the largest monthly payment For a deferred annuity: Be comfortable with the underlying investment Be alert to all possible fees

18. Constructing a retirement plan Step 1: Project retirement expenses Step 2: Identify sources and amounts of retirement income Step 3: Compare projected income and expenses, and develop a plan to assure adequate income

19. Projecting Retirement Expenses Bottoms-up approach: construct a budget for the first year of retirement Use rule of thumb Take current salary Figure average annual salary increase between now and retirement Project pre-retirement income, multiply by 80%

20. Sources of Retirement Income Social Security retirement benefits Can obtain estimate from Social Security, or make own projection Pension Income Withdrawals from tax-qualified plans Withdrawals from personal assets