New Ways to Save An Overview of Recent Developments in Retirement Funds

1. New Ways to SaveAn Overview of Recent Developments in Retirement Funds Team 2: Reginald Annoh-Ashley, Emily Carlson, QianGao, Chang Yeon Kim, John Mihalitsas, Zach Richardson, Andrew Spurling, Josh Zakas

2. Automatic Enrollment in 401(k)

3. Automatic Enrollment in 401(k) • A retirement investment plan offered by a corporation that allows employees to invest part of their income without paying income tax until after retirement when the money is withdrawn after retirement • 401(k) allows employees to reduce and shift the burden that is coming from retirement • Employees are automatically enrolled in a 401(k) plan unless they choose to opt out

4. 401(k) Risks • 401(k) is economically sensitive. • Inflation risk • Risk of concentrated stock • Longevity risk • Overly aggressive allocations • High record-keeping costs • Diversification choices • Eligibility requirements • Early cashing out

5. Automatic Enrollment in 401(k) Pros Cons • Secure future • Pre-tax contributions • Interest on investment • Employer matching • Rollover of retirement funds into IRA’s • Access to funds for legitimate purposes • High inflation rates • Taxable withdrawals • High management fees • Restricted investment choices • Mandatory withdrawals begin at age 70 and half • 10 percent penalty on early withdrawals

6. Step-Up Contributions

7. Step-Up Contributions • Employers are either automatically enrolled or have the option to enroll in a step-up contribution. • The employer contributes a larger percentage of their earnings into the fund each year. • Usually a raise of 1% per year of their paycheck • Stops growing after it reaches 6-10%. • Each year their interest rates improve or step-up to a higher level, and more money is accrued, rather than having a flat interest rate.

8. Step-Up Contribution Risks • If the economy boosts, then you could be stuck with a lower interest rate • The rate will not change unless you change employers • Financial Stress: more money is removed each year from your paycheck • Difficulties of extra retirement savings • If you retrieve your money early, you are penalized tax fees • The company could go under • Unexpected unemployment

9. Step-Up Contribution Example • Tim wants to retire in 25 years from his job with Deloitte Consulting. Jim starts with $60,000, and every 5 years on the job earns him a $10,000 pay raise. If he puts his money in a step-up option rather than a flat rate option for retirement, see what the differences are in his total benefit?

10. Step-Up Contributions Example, cont. Step-up: Contributions Years Interest 5% 1-5 3.0% 6% 6-10 4.0% 7% 11-15 6.0% 8% 16-20 7.0% 9% 21-25 9.0% Flat Rate:5%1-25 4.5%

11. Step-Up Contributions Example, cont. • Step-up: Total Benefit = 154,540 (25 years) • Flat Rate: Total Benefit = 104,500 (25 years) • Even though you have to put more of each paycheck in your retirement fund every 5 years, you are gaining nearly 50% more profit in using the step-up contribution option rather than the flat rate option

12. Life-Cycle Funds

13. Life-Cycle Funds • A highly diversified mutual fund designed to remain appropriate for investors in terms of risk throughout a variety of life circumstances • Accordingly, life-cycle funds offer different risk profiles that investors can shift invested funds between in order to manage risk effectively as they move from youth to middle age to retirement • Although life-cycle funds all share the common goal of first growing and then later preserving principal, they can contain any mix of stocks, bonds, and cash

14. Two Types of Life-Cycle Funds • Target Date: • Operates under an asset allocation formula that assumes you will retire in a certain year • Adjusts its asset allocation model as it gets closer to that year • The target year is identified in the name of the fund • Target Risk: • Three groups (based on risk tolerance) from which to choose: • Conservative • Moderate • Aggressive • If you decide later that your risk tolerance has changed as you get closer to retirement, you have the option of switching to a different risk-level

15. Life-Cycle Fund Risks • Investor Education • Asset Allocation • Inflation • Crash

16. Life-Cycle Fund Pros and Cons Pros Cons • You will receive professional management • The risk will change depending on how old you are • You are essentially putting all of your eggs in one basket • You will have to pay extra money for management • You will not have much control over where your money goes

17. Employee Stock Ownership Plan

18. Employee Stock Ownership Plan (ESOP) • The company creates a trust fund where they invest profits • The company then uses the trust fund to purchase their own stocks • Then the company distributes stocks to employees either equally or based on pay • Upon employee’s departure, the company buys back the employee’s stock and the money can be used for retirement

19. Risks Addressed by ESOP • Inflation • Grows with the market • Disability/unemployment/career change • Receipt of funds is not age-based • Employee still owns stocks • Death • Transferable to family • Change in social security policies • ESOP is immune to these changes

20. ESOP Pros and Cons Pros Cons • Corporate contributions are tax deductible • Employees are also afforded stock options to purchase (puts/calls) • Can be combined with additional retirement plans (401(k)s, IRAs, etc.) • Increases incentive among employees for their company to do well • No diversification because all the stock is in one company • Change in government policies can have a negative effect

21. Phased Retirement • When an employee nears retirement age, they have the option to scale down hours or work part-time for their employer after retirement • Pros • Allows additional income • Cons • Not fully retired: the employee still has to work • Risks it addresses • Not having enough money to retire completely for various reasons such as • Stock Market Crash • Divorce

22. Unused Vacation/Sick Days • Employees have the option to cash in unused sick and vacation days to help fund their retirement • Pros • If the days don’t roll over, you can still gain something from unused days • Cons • You could have taken a vacation or sick day • Risks Addressed • Helps add money to the retirement fund