1 / 20

Reasons for the Retirement Risk

Reasons for the Retirement Risk. 1. Retirement risk arises from uncertainty concerning the time of death 2. It is influenced by physiological and cultural hazards people tend to live longer today people are retiring earlier. Risks Associated with Superannuation.

raechel
Download Presentation

Reasons for the Retirement Risk

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Reasons for the Retirement Risk • 1. Retirement risk arises from uncertainty concerning the time of death • 2. It is influenced by physiological and cultural hazards • people tend to live longer today • people are retiring earlier

  2. Risks Associated with Superannuation • Two parts to the retirement risk • individual will not have accumulated sufficient assets by the time retirement arrives • assets that have been accumulated will not last for the remainder of his or her lifetime

  3. Retirement Risk Alternatives • 1. Some people attempt to avoid the retirement risk by not retiring. • 2. Continuing employment does not totally avoid the risk, since the probability of disability increases with age. • 3. The risk of outliving an accumulation can be transferred to an insurer. • 4. Some individuals transfer the retirement risk to their children or to society by not preparing for retirement.

  4. An Overview of Retirement Planning Process • 1. Estimate future income need • 2. Determine how the funds required to meet the need will be accumulated • 3. Plan the manner in which the accumulation will be consumed

  5. Sources of Retirement Funding • 1. The first leg: Social Security • 2. The second leg: Qualified pensions and profit sharing plans • 3. The third leg: Personal savings

  6. First Line of Defense: Social Security • 1. Old-age part of OASDI provides a lifetime pension to workers and their dependents at age 65, with a reduced benefit at age 62. • 2. Social security provides about 60% of retirement needs for minimum wage earners and about 30% of need for those who earned maximum FICA wage base. • 3. Social security provides a solid base, but is generally inadequate to allow continuation of pre-retirement standard of living.

  7. Second Line of Defense: Qualified Retirement Plans • 1. A “qualified” plan is one that meets requirement of federal tax laws and receives favorable tax treatment. • 2. Contributions by the employer are deductible at the time made, but benefits are not taxable to beneficiary until they are received at retirement. • 3. Investment income on accumulating funds is not taxed until it is paid out to the employee at retirement.

  8. Final Line of Defense: Personal Savings • Investments for the Accumulation Fund • Financial planners have identified criteria that should be considered in selecting long-term investments for the retirement accumulation: • 1. Rate of return • 2. Vulnerability to inflation • 3. Tax treatment • 4. Safety

  9. Estimating Retirement Needs • 1. Monthly income needs during retirement are projected by some assumed rate of inflation together with social security benefits, which are deducted from needs. • 2. If pension benefits will be available, projected pension benefits are also deducted from projected need. • 3. Remaining monthly need is converted to an annuity purchase price to determine total future capital need.

  10. Estimating the Aggregate Need • Two ways in which future income needs can be estimated: • 1. Construct a budget for post-retirement living, estimating costs for housing, food, other necessities, medical expenses and so on. • 2. Set retirement need at some percentage (e.g., 65%, 70%, or 75%) of pre-retirement income, which is determined by projecting present income at selected growth rate.

  11. Inventory of Available Resources • 1. Project Social Security benefits at same growth (inflation) rate as income is projected. • 2. If pension benefits will be available, projected pension benefits are also deducted from projected need. • 3. Remaining monthly need is converted to an annuity purchase price to determine total future capital need.

  12. Estimating the Accumulation Need • Annuity purchase price used to convert monthly income need into a principal amount • Male age 65 $10 monthly benefit = $1,100 • Female age 65 $10 monthly benefit = $1,350 • $3,000 monthly need $10 monthly benefit= 300 units • 300 units X $1,350 = $405,000

  13. Post-Retirement Inflation • The problem with this calculation is that it does not allow for inflation that occurs after retirement commences. • allowing for inflation requires projecting an increasing amount of withdrawals from a principal sum • in selecting the period for which the increasing withdrawals are made, planner makes an assumption about longevity or life expectancy

  14. Table 19.3 Illustration • Projected Tax Pre-Tax Projected Discount Pre-TaxAge Need Multiplier Need OASDHI Gap Rate Need • 64 $90,000 $ $ 47,505 • 65 67,500 119% 80,325 48,931 $31,394 1.000000 $31,394 • 66 69,525 119% 82,735 50,398 32,336 0.934579 30,221 • 67 71,611 120% 85,933 51,910 34,022 0.873439 29,717 • ** ****** ***** ****** ****** ****** ********** ******* ** ****** ***** ****** ****** ****** ********** ******* ** ****** ***** ****** ****** ****** ********** ******* ** ****** ***** ****** ****** ****** ********** ******* • 89 $137,214 133% $182,494 $99,466 $83,028 0.197147 16,369 • $542,110

  15. Planning the Accumulation • Accumulation goal $550,000 • Years until retirement 40 • Assumed interest rate 7.0% • $1 annually at 7% for 40 years $213.61 • $550,000 213.61 = $2,575 (annually) • $2,575 12 = $215 (monthly)

  16. Managing the Distribution • 1. Capital Retention Strategy • 2. Capital Liquidation Strategy • Capital retention strategy is subject to I.R.C. requirements concerning required distributions from tax-sheltered accumulations.

  17. Required Distributions • 1. Distributions must begin by April 1 of the year following the year in which participant reaches age 70 1/2. • 2. Funds must be paid out over a period not exceeding the life expectancy of the participant (or participant and spouse). • 3. Tax penalty equal to 50% of amount which should have been but was not paid out. • 4. Delay of distribution until 70 1/2 increases rate at which payout occurs.

  18. Distribution Options • 1. Life annuity • 2. Withdrawal based on life expectancy • 3. Minimum distribution option (calculated by insurer or fund custodian)

  19. Distributions • 1. Variable annuity distribution • 2. Variable distributions under non-variable annuities • standard payment method • graded payment method

  20. Pension Maximization • 1. Strategy based on ERISA requirement for a joint and survivor benefit. • 2. Participant (and spouse) reject joint and survivor benefit and use part of the higher single-life benefit to purchase insurance on the annuitant. • 3. Premium on annuitant spouse must be less than difference in benefits.

More Related