1. Chapter 14 Starting Early: Retirement and Estate Planning Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. 14-2 Retirement Planning Chapter Learning Objectives LO14.1Analyze your current assets and liabilities for retirement and estimate your retirement living costs. LO14.2Determine your planned retirement income and develop a balanced budget based on your retirement income. LO14.3Analyze the personal and legal aspects of estate planning. LO14.4Distinguish among various types of wills and trusts.

3. 14-3 Misconceptions About Retirement Planning You have plenty of time to start saving for retirement … Saving just a little bit won’t help … You’ll spend less money when you retire … My retirement will only last 15 years … You can depend on Social Security and a company pension to pay your basic living expenses … Your pension benefits will increase to keep pace with inflation … Your employer’s health insurance plan and Medicare will cover all your medical expenses when you retire… Learning Objective LO14.1 Analyze Your Current Assets and Liabilities for Retirement and Estimate Your Retirement Living Costs

4. 14-4 The Importance of Starting Early Take advantage of the time value of money –Start at age 25: Invest $127 a month At 11% APR For 40 years –Start at age 50: Invest $ 2,244 per month At 11% APR For 15 years N = 480 months I/Y = 0.9167 = 11%/12 PMT= -127 PV = 0 FV CPT = $1,092,216 N= 180 = 15 yrs x 12 I/Y= 0.9167 PMT CPT = - $2,244 PV = 0 FV= $1,020,362

5. 14-5 Conducting a Financial Analysis Assets - Liabilities = Net Worth – Ideally net worth should increase each year Housing –If owned, probably your biggest single asset –If large equity, a reverse mortgage could provide additional retirement income –Sell your home, buy a less expensive one, and invest the difference

6. 14-6 Conducting a Financial Analysis Life Insurance –May reduce coverage as you near retirement and children are self-sufficient –Increase income by lowering premiums Other Investments –After retirement, consider changing your objective from growth to income

7. 14-7 Estimating Retirement Living Expenses Spending patterns and where and how you live will probably change Some expenses may go down or stop:  401(k) retirement fund contributions  Work expenses - less for gas, lunches out  Clothing expenses - fewer and more casual  Housing expenses - house payment may stop if your house is paid off  Federal income taxes will probably be lower

8. 14-8 Estimating Retirement Living Expenses Other expenses may go up  Life and health insurance unless your employer continues coverage  Medical expenses increase with age  Expenses for leisure activities  Gifts and contributions Inflation will increase amount needed to cover expenses over the course of retirement

9. 14-9 How an “Average” Older (65+) Household Spends its Money Source: U.S. Bureau of Labor Statistics

10. 14-10 Learning Objective LO14.2 Determine Your Planned Retirement Income and Develop a Balanced Budget Based on Your Retirement Income Major Sources of Retirement Income Employer Pension Plans Public Pension Plans Personal Retirement Plans Annuities

11. 14-11 Plans Employer Pension Plans Defined Contribution An individual account to which the employer contributes a specific amount annually –Money-purchase pension plans % of earnings set aside annually, along with any employer contributions –Stock bonus plans Employer’s contribution buys stock in your company for you –Profit-sharing plans Employer’s contribution depends on the company’s profits

12. 14-12 Employer Pension Plans Defined Contribution 401(k) plan Salary-reduction plan Employer makes non-taxable contributions and reduces your salary by the same amount Employee contributions are tax-deferred Some employers match a portion of your contribution Funds invested in stocks, bonds, & mutual funds Vesting period

13. 14-13 Employer Pension Plans Defined Benefit Employer will pay you a certain amount per month when you retire based on: – Pre-retirement salary – Number of years of service Employers make the investment decisions for your contribution and theirs Your benefit amount stays the same regardless of how the investments perform

14. 14-14 Employer Pension Plans Portability of Plans –Allows you to carry earned benefits from one employer’s pension plan to another when you change jobs ERISA –Employee Retirement Income Security Act of 1974 –Sets minimum standards for pension plans –Federal government insures part of the payments promised by defined-payment plans

15. 14-15 Public Pension Plans Most widely used source of retirement income, covering 97% of U.S. workers Meant as part of your retirement income, not the sole source Check the Earnings & Benefit statement you receive each year for accuracy See www.ssa.govwww.ssa.gov Social Security

16. 14-16 Public Pension Plans Full retirement benefits at age 65 to 67 –Depends on year of birth –Reduced benefits at age 62 –Full retirement age being increased in gradual steps Benefits based on earnings over the years –Must earn a certain number of credits to qualify Certain dependents may receive benefits Social Security Eligibility

17. 14-17 Personal Retirement Accounts Individual Retirement Accounts (IRA) Regular (traditional) IRA –Allows $5,000 contribution in 2012 and beyond $6,000 if over 50 –Contribution may be tax-deductible, depending on your tax filing status and income –Interest accumulates tax free until you begin withdrawal –May begin withdrawing at 59 ½ –Must begin withdrawing at 70 ½ –Withdrawals are taxable income

18. 14-18 Individual Retirement Accounts Roth IRA –Contributions are not tax deductible –Distributions tax free after age 59 ½ –Same contribution limits as traditional IRA If you are single with an AGI < $120,000 or If you are filing jointly with an AGI < $176,000 Can continue to contribute even after age 70 ½ –After five years, withdrawals are tax free and penalty free, if: You are at least 59 ½ … or Funds used as a down payment on a first-time home purchase

19. 14-19 Individual Retirement Accounts Simplified Employee Pension (SEP) –IRA funded by the employer –Employer can make annual contributions up to $50,000 –Employee’s contributions fully tax deductible –Simplest retirement plan for the self-employed Spousal IRA –Contributions for a nonworking spouse if filing a joint return –Contribution limits same as for Roth or Traditional IRAs

20. 14-20 Rollover IRA –Traditional IRA allowing transfer of all, or a portion, of your taxable distribution from a retirement plan or other IRA Education IRA –Coverdell Education Savings Account –May give up to $2,000 a year to each child under age 18 –Contributions not tax-deductible –Tax-free distributions for education expenses Individual Retirement Accounts

21. 14-21 Keogh Plans –H.R. 10 plan or self-employed retirement plan –Designed for the self-employed –Annual tax-deductible contributions limited –Can be difficult to administer Limits on Personal Plans –Cannot leave money in a tax-deferred retirement plan forever (except for Roth IRA) –At retirement or by age 70½ you must begin to receive a minimum lifetime distribution

22. 14-22 Types of IRAs

23. 14-23 Annuities Provides guaranteed income for life –Purchase with proceeds of an IRA or company pension –Use as supplemental retirement income –Single or periodic payments Interest accumulates tax free until payments begin; distributions taxed as ordinary income Immediate annuity = payments begin right away Deferred annuity = payments begin at some future date

24. 14-24 Anticipated Sources of Retirement Income Social Security Administration

25. 14-25 Living on Your Retirement Income Estimate a retirement budget If funds are not enough: – First, make sure you are getting all the income you are entitled to – Convert assets into cash or sources of income – Consider the trade-off between spending and saving – Consider working during retirement – Dip into your nest egg cautiously and consider what you would like to leave for your heirs

26. 14-26 Learning Objective LO14.3 Estate Planning Your estate = everything you own Estate planning = a detailed plan for the administration and disposition of your property during your lifetime and at your death –While you work you accumulate funds for your future and for your dependents. –As you grow older, your emphasis will shift from accumulating assets to distributing them wisely

27. 14-27 Estate Planning Phases 1.Build estate through savings, investment, and insurance 2.Ensure that your estate is distributed as you wish after your death –If married: consider needs of spouses –If single: financial affairs in order for beneficiaries –Make sure important documents are accessible, understandable, and legally proper

28. 14-28 Legal Documents Birth, marriage, and divorce documents Legal name changes Military service records Social Security documents Veteran’s documents Insurance policies Transfer records of joint bank accounts Safe-deposit box records Automobile registration Titles to stock and bond certificates

29. 14-29 Learning Objective LO14.4 Types of Wills and Trusts Wills The legal declaration of a person’s mind as to the disposition of his or her property after death Have an attorney draft your will to avoid difficulties A standard will can cost between $300-$400

30. 14-30 Types of Wills 1. Simple or “I love you” will  Leaves everything to your spouse  Sufficient for small estates 2. Traditional marital share will  Leaves 1/2 to spouse, 1/2 to children of your issue or heirs  May be held in a trust  Trust = arrangement by which a designated person manages assets for the benefit of someone else

31. 14-31 Types of Wills 3. Exemption trust will  Passes to your spouse except for an amount equal to the exemption, which passes into a trust  Trust can provide a lifelong income 4. Stated amount will  Allows you to pass along to your spouse any amount that satisfies the family’s financial needs

32. 14-32 Intestate and Probate Intestate –You die without a will –The state distributes your assets –May mean the state will decide on a guardian for your children –Very complicated if a “blended” family Probate –Probate court generally validates wills and makes sure your debts are paid –Expensive, lengthy, and public

33. 14-33 Will Formats Holographic will –Will that you write, date and sign, entirely in your handwriting –May not be recognized in some states Formal will –Usually prepared with attorney’s assistance –You must sign and have two witnesses, neither of whom can be beneficiaries –Beneficiary = person you have named to receive property

34. 14-34 Will Formats Statutory will –A type of formal will on a preprinted form –Available from a lawyer or stationery store –May include provisions which are not in the best interest of your heirs

35. 14-35 Writing Your Will Selecting an Executor Executor: one who is willing and able to execute the provisions of your will. Tasks may include: Preparing an inventory of your assets Collecting any money due and paying off debts Filing all income and estate tax returns Making decisions about investing or selling assets to pay off debts or provide income Distributing the estate and making a financial accounting to your beneficiaries

36. 14-36 Writing Your Will Selecting a Guardian A guardian assumes the responsibility for providing the children with personal care and managing the estate for them Don’t forget any pets in the home! –They need a guardian, too

37. 14-37 Reasons to review your will: –You move to a new state with different laws –You have sold property mentioned in the will –The size and composition of your estate has changed –You have married, divorced or remarried –Potential heirs born or died Adding a codicil –Document that explains, adds or deletes provisions in your existing will Altering or Rewriting Your Will

38. 14-38 Living Will – Allows you to specify whether or not to be kept on artificial life support “Do Not Resuscitate” (DNR) – May also appoint someone to make health care decisions on your behalf in case you are unable to do so

39. 14-39 Power of Attorney –Legal document authorizing someone to legally act on your behalf if you become seriously ill or injured Health Care Power of Attorney –Combines a living will and power of attorney for use in making health related decisions

40. 14-40 Letter of Last Instruction Not legally binding Provides heirs with information Could include: –Funeral preferences –Names of people to be notified of your death –Location of bank accounts and safe deposit box –Assets and debts –Social Security number –Disposition of personal effects

41. 14-41 Trusts Legal arrangement through which a trustee holds your assets for your benefit or that of your beneficiaries –Trustee may be an individual or an institution Benefits of Trusts: –Reduce estate taxes –Avoid probate; transfer assets immediately –Free you from managing assets –Provide income for a surviving spouse –Ensures property serves desired purpose after your death

42. 14-42 Types of Trusts Revocable trust –You retain the right to end the trust or change its terms during your lifetime –May avoid the lengthy probate process –Does not provide shelter from federal or state estate taxes Irrevocable trust –You cannot change the terms once instituted –Used to reduce estate taxes –Avoids probate

43. 14-43 Types of Trusts Credit-shelter trust –“Bypass trust” –“Residuary trust” –“A/B trust” –“Exemption equivalent trust” –“Family trust” –Enables surviving spouse to avoid federal taxes on a certain amount of assets

44. 14-44 Types of Trusts Disclaimer trust –For couples without enough assets to warrant a credit-shelter trust but may in the future –Surviving spouse receives everything but may “disclaim” or deny some assets Anything disclaimed goes into a credit-shelter trust –Protects wealth from estate taxes

45. 14-45 Types of Trusts Living trust –“Inter vivos trust”; in effect while you are alive –Property management arrangement –Advantages: Insures privacy; Assets in trust avoid probate Allows review of trustee performance Relieves you of management responsibilities Less likely to create arguments among heirs Can guide family and doctors if you are unable to make decisions Testamentary trust –Established by your will

46. 14-46 Taxes And Estate Planning Estate taxes –Federal tax on value of property at death –Tax on fair market value –$5.12 million exempt in 2012 Estate and Trust Federal Income taxes –Estates and certain trusts must file tax returns –Trusts and estates must pay quarterly estimated taxes

47. 14-47 Taxes And Estate Planning Inheritance taxes –Tax on property left by a person in his/her will –Imposed by states –4 to 10% on average Gift taxes –Tax on gifts >$13,000 given by one person to another in a single year –Imposed by both state and federal governments

48. 14-48 Chapter Summary Learning Objective LO14.1 Net worth = Assets - Liabilities Review your assets to ensure they are sufficient for retirement. Estimate your living expenses. –Some expenses are likely to decrease while others will increase.

49. 14-49 Chapter Summary Learning Objective LO14.2 Possible sources of income during retirement include: –Employer pension plans –Public pension plans –Personal retirement plans –Annuities If your income approximates your expenses, you are in good shape; if not, determine additional income needs and sources.

50. 14-50 Chapter Summary Learning Objective LO14.3 The personal aspects of estate planning depend on whether you are single or married. Never having been married does not eliminate the need to organize your financial affairs. Every adult should have a written will. A will is a way to transfer your property according to your wishes after you die.

51. 14-51 Chapter Summary Learning Objective LO14.4 The four basic types of wills are: –Simple will –Traditional marital share will –Exemption trust will –Stated amount will Types of trusts include: –Credit-shelter trust –Disclaimer trust –Living trust –Testamentary trust Federal and state governments impose various types of estate taxes