Chapter 15

Retirement
Planning
 Learning Objectives

1. Understand the changing nature of

retirement planning.
2. Set up a retirement plan.
3. Understand how different retirement plans
work.
4. Choose how your retirement plans are paid
out to you.
5. Put together a retirement plan and
effectively monitor it.

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 Introduction

• Today, you’ve got to come up with

retirements funds by yourself.

• Despite Social Security reform proposals,

there might not be Social Security when you
retire.

• Need to know about Social Security,

employer-funded pensions, and current
retirement plans.
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 Social Security and Employer-
Funded Pensions

• Primary source of retirement income for

many senior citizens.

• Younger workers who won’t retire for

another 40 years, Social Security may no
longer be there.

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 Financing Social Security

• FICA taxes paid today are providing benefits

for today’s retirees.

• The money you pay is not being saved up

and invested in an account for you.

• Changes will be necessary, possibly

increasing the retirement age or limiting
benefits for the wealthy.

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 Eligibility

• 95% of Americans are covered.

• Pay into system to be eligible and receive

credits.

• In 2014, earned 1 credit for each $1,200 in

earnings up to a maximum of 4 credits per
year.

• With 40 credits, eligible for retirement,

disability, and survivor benefits.

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 Retirement Benefits

• Benefits formula—replace 42% of average

earnings based on number of earnings
years, average level of earnings,
adjustments for inflation, income brackets.

• Full benefits at the “full” retirement age.

• Reduced benefits at age 62.

• Increased benefits if you delay retirement.

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 Disability and Survivor Benefits

• Provided through mandatory Social Security

insurance program.

• Protection for those with impairment that

keeps them from work for at least 1 year.

• Monthly survivor benefits when breadwinner

dies.

• One-time death benefit for funeral costs.

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 Employer-Funded Pensions

• People used to work for the same company

all of their working life and the company
would support their employees through
retirement

• Today, pension plans are rare

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 Defined-Benefit Plans

• Traditional pension plan where you receive

“defined” pension payout at retirement

• Noncontributory retirement plan

• Contributory retirement plan

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 Defined-Benefit Plans

• Portability

• Vested

• Funded pension plan

• Unfunded pension plan

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 Cash-Balance Plans: The Latest
Twist in Defined-Benefit Plans

• Workers are credited with a percentage of

their pay each year, plus a predetermined
rate of interest.

• Employers contribute a percentage of your

salary each year into an account which
grows at 30-year Treasury bond rate.

• Benefits easier to track and portable.

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 Plan Now, Retire Later

• Step 1: Set Goals

– How costly a lifestyle will you lead?
– Do you want to live like a king?
– Do you have costly medical conditions?
– Will you relocate or travel?
– Do you want to live in your own home or
retirement community?
– Decide on the time frame for achieving your
goals.

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 Plan Now, Retire Later

• Step 2: Estimate How Much You Will Need

– Turn your goals into dollars by estimating how
much you will need.
– Begin with 70-80% of current living expenses to
calculate the cost to support yourself in
retirement.
– Don’t forget about paying taxes.

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 Plan Now, Retire Later

• Step 3: Estimate Income at Retirement

– Once you know how much you need, figure out
how much you’ll have.
– Estimate Social Security benefits and determine
what your pension will pay.

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 Plan Now, Retire Later

• Step 4: Calculate the Annual Inflation-

Adjusted Shortfall
– Compare the retirement income needed with the
retirement income you’ll have.

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 Plan Now, Retire Later

• Step 5: Calculate How Much You

Need to Cover This Shortfall

– Know your annual shortfall in your retirement

funding.

– Know how much must be saved by retirement to

fund this shortfall.

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 Plan Now, Retire Later

• Step 6: Determine How Much You Must

Save Annually Between Now and Retirement

– Put money away little by little, year by year.

– Use online retirement planning websites

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 Plan Now, Retire Later

• Step 7: Put the Plan in Play and Save

– Hardest step

– Have to know the choices before you can make a

choice

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 What Plan Is Best For You?

• Most plans are tax-deferred.

• Contributions can be made on fully or
partially tax-deductible basis.
• Earn compound interest on non-taxed
contributions and earnings.
• Taxed when you withdraw funds.

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 Retirement Plans

• Employer-Sponsored Retirement Plans

– Defined-Contribution Plans allows you and your
employer to contribute toward your retirement
account

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 Defined-Contribution Plan

• You and employer or your employer alone

contributes directly to a retirement account
set aside for you.

• A savings account for retirement.

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 Defined-Contribution Plans

• Profit-Sharing Plans

• Money Purchase Plan

• Thrift and Savings Plan

• Employee Stock Ownership Plan (ESOP)

• 401 (k) Plan

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 Defined-Contribution Plans

• How much can you contribute?

• Limits on the rise.

• $17,500 for 401(k) and 403(b) plans in

2014 rises annually by $500 with inflation.

• “Catch up” of additional $5,500 (also

indexed for inflation) for those over 50.

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 Retirement Plans for the
Self-Employed and Small Business
Employees
• Keogh Plan or Self-Employed Retirement
Plan

• Simplified Employee Pension Plan (SEP-IRA)

• Savings Incentive Match Plan for Employees

or SIMPLE plan

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 Individual Retirement
Arrangements (IRAs)

• Traditional IRA
• Roth IRA
• Coverdell Education Savings Account
(known as Education IRA)

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 Traditional IRAs

• Tax advantaged—contribution may or may

not be tax-deductible depending on
individual’s level of income and whether
he/she, or spouse, is covered by a company
retirement plan.

• Restrictions on timing and amount of

withdrawals but can rollover a distribution.

• Saver’s tax credit

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 The Roth IRA

• Contributions are not tax deductible but

made out of after-tax income.

• Money grows tax free and withdrawals are

tax free.

• No withdrawal restrictions or tax penalty like

traditional IRA but can also rollover.

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 Traditional Versus Roth IRA:
Which is Best for You?

• You end up with the same amount to spend

at retirement, if both are taxed at the same
rate.

• Choose the Roth IRA if you can pay your

taxes ahead of time.

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 Saving for College: The Coverdell
Education Savings Accounts (ESA)

• Works like a Roth IRA, except contributions

are limited to $2,000 annually per child
under 18.
• Income limits begin at $95,000 for singles,
and $190,000 for couples.
• Earnings are tax-free and no taxes on
withdrawals to pay for education.

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 Saving for College: 529 Plans

• Tax-advantaged savings plan used for

college and graduate school.
• Contribute up to $250,000 to $330,000
(depending on the state), grows tax-free.
• Plans are sponsored by individual states,
open to all applicants regardless of where
they reside.
• Invest directly or through financial advisor.

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 Facing Retirement—The Payout

• Plan ahead before you decide how you

receive a payout.

• Look at all your retirement plan payouts

together—may want some in lump sum,
others as annuity.

• Use diversification and time dimension of

risk when deciding what to do with funds.

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 An Annuity, or Lifetime Payments

• Single Life Annuity

• An Annuity for Life or a “Certain Period”
• Joint and Survivor Annuity
• A Lump-Sum Payment

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 Tax Treatment of Distributions

• Annuity payouts are generally taxed as

normal income.
• Can pay all taxes at one with lump sum or
have the distribution “rolled over” into an
IRA or other qualified plan.
• With rollover can avoid paying taxes on the
distribution while the funds continue to grow
on a tax-deferred basis.

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 Putting a Plan Together
and Monitoring It

• Most people rely on retirement savings from

a combination of different plans.
• Start with the seven steps.
• Invest maximum allowed in tax-sheltered
plans according to your investment time
horizon.
• Monitor before and after retirement.

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 Saving for Retirement—Let’s
Postpone Starting for One Year

• One year delay can cost you a lot—almost

$235,000.

• Only end up with more when you begin

saving for retirement earlier.

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 Summary

• Social Security benefits are determined by

number of years of earnings, the average
level of earning, an adjustment for inflation.

• Funding retirement needs follows a seven-

step process from setting goals to putting
the plan in place and saving.

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 Summary

• Tax-favored retirement plans can be

employer-sponsored, for self-employed, or
individual retirement accounts—where
contributions and earnings are not taxed.

• Retirement benefits can be received as a

lump sum, annuity, or combination.

• Monitor retirement saving before and after

you retire for new, unexpected changes.
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