Section 36.1

1. Section 36.1

2. Chapter Retirement and Wills 36 Section 36.1 Retirement Income Section 36.2 Estate Planning

3. What You’ll Learn • How to describe the main features of social security (p. 772) • How to discuss the retirement benefits offered by employer pension plans (p. 773)

4. What You’ll Learn • How to explain the pension rights given to employees under ERISA (p. 775) • How to distinguish among the various personal retirement plans (p. 776)

5. Why It’s Important Learning about different types of retirement plans will help you predict what your financial situation and needs will be when you retire.

6. Legal Terms • pension plan (p. 773) • 401(k) plan (p. 774) • vesting (p. 775) • portability (p. 775) • Individual Retirement Account (IRA) • (p. 776) • Keogh Plan (p. 778)

7. Section Outline Public Pension Plans Social Security Employer Retirement Plans Defined-Benefit Plans Defined-Contribution Plans Employee Retirement Income Security Act

8. Section Outline Personal Retirement Plans Individual Retirement Accounts Keogh Plans

9. Pre-Learning Question What are some public pension plans?

10. Public Pension Plans The federal government administers • social security • railroad pensions • military pensions • civil service pensions

11. Public Pension Plans Many state and local governments also provide pensions for their employees.

12. Social Security Social security provides income to people when their regular income stops because of retirement, disability, or the death of someone who had provided them with income.

13. Social Security You and your dependents become eligible for social security benefits when you work at a job that is covered by social security.

14. Pre-Learning Question Why types of retirement plans do employers offer?

15. Employer Retirement Plans A pension plan is a retirement plan that is funded at least in part by an employer. The company where you work may offer a pension plan to supplement social security.

16. Employer Retirement Plans If the plan is financed entirely by the employer, it is called a noncontributory pension plan.

17. Employer Retirement Plans If it is financed by the employee alone or with contributions from both employer and employee, it is called a contributory pension plan.

18. Employer Retirement Plans Under a 401(k) plan, employees agree to forgo a bonus or take a salary reduction to invest in a retirement plan. Employers sometimes match the amount contributed by employees.

19. Defined-Benefit Plans Defined-benefit plans are the most common type of employer pension plan.

20. Defined-Benefit Plans Under this type of plan, employees receive a definite, predetermined amount of money upon retirement or disability. The fixed amount is based on an employee’s years of service.

21. Defined-Contribution Plans In defined-contribution plans, an employer pays a certain amount into a pension fund every month (or year) for each employee. The amount is usually a fixed percentage of the employee’s wages or salary.

22. Employee Retirement Income Security Act The Employee Retirement Income Security Act (ERISA) places many controls on the management of pension funds and gives certain rights to workers.

23. 36.1 Employee Retirement Income Security Act Under ERISA Employers must place employees’ pension contributions into a pension trust, independent of the employer. Workers are guaranteed the right to receive pension benefits regardless of whether they are working under the plan at the time of retirement. Employees’ contributions vest immediately. All pension benefits must vest after a worker has been on the job for three years. Workers may transfer benefits from one company’s pension plan to the plan of another company or from an individual retirement plan to a company plan.

24. Employee Retirement Income Security Act The vesting of retirement benefits is the act of giving a worker a guaranteed right to receive a future pension.

25. Employee Retirement Income Security Act The ability to transfer pension benefits from one job to another is called portability.

26. Rose works for a small steel manufacturer. Upon retirement Rose will receive $45 per month for each year of service. What type of benefit plan does her employer provide?

27. ANSWER Defined-benefit plan

28. Alejandro’s employer, an architectural firm, pays 4 percent of Alejandro’s annual salary of $50,000 into a pension fund every year. What type of benefit plan does his employer provide?

29. ANSWER Defined-contribution plan

30. Luther’s employer offers a pension plan in which it matches every dollar Luther contributes up to $2,500 per year. In other words, his employer will contribute as much as Luther does to his pension fund up to $2,500.

31. So if Luther contributes $2,000 one year, his employer contributes $2,000 that year, too. What type of pension plan does Luther’s employer provide?

32. ANSWER Contributory pension plan.

33. Pre-Learning Question When should a person begin planning for retirement?

34. 36.1 Benefits of Starting a Retirement Plan Early

35. Personal Retirement Plans Self-employed persons and employees who are not covered by company pension plans have the same retirement needs as others. However, the retirement funds for these people must come from their own pockets.

36. Individual Retirement Accounts An Individual Retirement Account (IRA) is an individual’s own personal pension plan. It is a system of providing for retirement by saving part of your earnings every year.

37. Types of IRAs • Regular or Traditional IRA • Roth IRA • Simplified Employee Pension Plan (SEP) IRA

38. Types of IRAs • Simple IRA • Spousal IRA • Rollover IRA • Education IRA

39. Traditional IRA Amounts up to $3,000 (increasing to $5,000 by 2008) may be set aside annually for retirement.

40. Traditional IRA Contributions are tax deductible if your income is below a certain amount, and interest is tax deferred until the money is withdrawn. Funds cannot be withdrawn without penalty before age 59½.

41. Roth IRA Distributions, or withdrawals, are not required during your lifetime. When taken after age 59½, distributions are tax free if you have had the account for five years.

42. Education IRA Can be established for a child under age eighteen by anyone who wants to save for the child’s college education. The interest on the savings is tax free, and there is no early withdrawal penalty.

43. Simplified Employee Pension Plan This IRA is funded by an employer. Money is withheld from an employee’s pay and placed in the IRA. Employers may contribute up to 15 percent of the employee’s pay or $25,500—whichever is lower.

44. Simplified Employee Pension Plan The money invested in the plan is not taxed until it is withdrawn and cannot be withdrawn without penalty before the age of 59½.

45. Keogh Plans A Keogh plan is a retirement plan for self-employed people and their employees. Contributions to the plan are tax deductible, and the interest earned is tax-deferred until the money is withdrawn.

46. Section 36.1Assessment Reviewing What You Learned • What is the purpose of social security?

47. Section 36.1Assessment Reviewing What You Learned Answer Provides income to people when their regular income stops because of retirement, disability, or the death of someone who has provided them with income.

48. Section 36.1Assessment Reviewing What You Learned • Explain the difference between a noncontributory and a contributory pension plan.

49. Section 36.1Assessment Reviewing What You Learned Answer A pension plan financed entirely by the employer is called a noncontributory pension plan. A plan financed by employees alone or jointly by employees and employers is contributory.

50. Section 36.1Assessment Reviewing What You Learned • What are the pension rights given to people under ERISA?