Retirement Planning Guide: Secure Your Financial Future

1. Retirement Planning Chapter 16

2. Introduction • Average life expectancy is over 70 years • 100 years ago it was about 55 years so there wasn’t much need for retirement planning • If you retire when you are 65, you may still have 20+ years remaining and you’ll need money during that time

3. Introduction • One fundamental error many people make is not diversifying properly • Enron employees, for example • The earlier you start saving for retirement the easier it is • The key is planning

4. Threats and Protections • Protections • Employer pension plans • Retirement savings plan • Social security • Wise investing and spending • Medicare • Health insurance • Estate planning • Threats • Inflation • Heath-care expenses • Cost of long-term care • Estate taxes • Income taxes • State and local taxes

5. A Time Line for Making Important Choices • The time line starts TODAY • During your working years you need to periodically review you retirement plan • By age 50 you should start thinking more about what you’d like to do during retirement • By age 55 you can begin withdrawing money from several retirement plans without penalty • By age 59½ more options are available • By age 65 (the “traditional” retirement age) you become eligible for many important benefits • By age 70½ you must begin withdrawing money from most retirement accounts

6. Factors That Determine Your Savings Needs • Your current age • Your current income • Your desired retirement income • Your current retirement savings • Other sources of retirement income (Social Security, etc.) • Your tax rate • The expected rate of inflation • The expected return on your retirement savings

7. The Lessons of Saving for Retirement • Start early and stick with it • Save as much as you can afford each month • It’s the savings today that will be earning you the most interest on interest • Take advantage of tax deferred retirement plans • Don’t be too conservative with your investments • While you’re young, you can handle fluctuations in your retirement funds

8. Understanding the Social Security System • Old Age and Survivors Insurance Fund • Provides monthly benefits to retired workers and their survivors • Disability Insurance Trust Fund • Provides benefits to partially or totally disabled workers • Hospital Insurance Trust Fund (Medicare—Part A) • Supplementary Medical Insurance Trust Fund (Medicare—Part B) • Provides health-care benefits to elderly Americans

9. Social Security • FICA (Federal Insurance Contributions Act) deductions represent the amount you contribute to Social Security • Initially tax was 1% on earnings up to $3000 • Today rate is 15.3% of earnings up to a set amount that changes yearly (in 2002 it was $83,000) • 12.4% goes to Old Age fund and 2.9% to Hospital Trust fund • Earnings above the limit are still subject to 2.9% Medicare tax • ½ of tax is paid by you and ½ is paid by employer

10. Applying for Social Security Benefits • Once you become eligible for benefits, you must apply • Provide evidence that you qualify • Birth certificate is generally sufficient • Recent W-2 or tax return • The age at which you can receive benefits is rising • Currently it’s about 65 ½ but if you were born after 1960, it’s 67

11. Computing Your Retirement Benefits • Based on what you’ve earned throughout your working life (rather than the last few years of your career) • If you begin withdrawing social security at the ‘normal’ retirement age, your benefit is determined based on the average amount you’ve earned (inflation-adjusted) over the past 35 years • Request a Personal Earnings and Benefits Estimate Statement (PEBES) • Make certain it’s accurate (your earnings)

12. Other Social Security Issues • Individual vs. Family benefits • Retired workers as well as dependent spouse and young children receive benefits • Upper limit exists to total Social Security benefits one family can receive • Survivor benefits • If you die (even before you reach retirement age) your spouse and children under age 18 will receive survivor benefits • Working after retirement • If you work (even part-time) after retirement, you may lose some of your benefits

13. The Future of the Social Security System • Will it be around by the time you retire? • By 2025 the social security system will be paying out more than it is taking in • Since the program began in 1930s, it has been ‘fixed’ 42 times • ‘Fixes’ usually mean raising taxes or the wage base • Suggested changes • Invest some of current surplus in stocks • Force workers to save via mandatory retirement accounts • We don’t know what will happen with Social Security, so plan for your own retirement

14. Employer-Sponsored Retirement Plans • Will probably provide bulk of your retirement income • Qualified retirement plan—meets certain legal requirements and offers tax advantages to both employer and employee • Defined benefit plans—you are guaranteed a certain benefit each year [Ex: pension plan] • Defined contribution plan—employer guarantees a yearly contribution while you’re working but doesn’t guarantee a retirement benefit [Ex: 401(k) and 403(b) plans] • Trend is toward these plans and away from defined benefit plans, but some employers offer both

15. Defined Benefit Plan • Many plans are fully funded by employer but others require contribution by employee • Benefits paid based on employee’s income and the number of years employed at company • General rule of thumb—multiply number of years you’ve worked for company by 0.015 times your final salary to estimate your annual pension benefit

16. Defined Benefit Plan • Many plans state that if you leave your employer before certain number of years have passed, will lose all or part of retirement benefits (i.e., you are not vested) • Once you are vested, your benefits upon retirement are guaranteed • Many pension plans are not being adequately funded • ERISA attempts to protect employees, but doesn’t cover state and local government employees

17. Key Questions to Ask • About defined benefit plans • What are the vesting requirements? • What benefits have been credited to your account as of now • Will receive periodic report • What is minimum age for a full pension? Early retirement? • Are pension rights protected during leaves of absence, disability, layoffs? • Is the plan fully funded? • Does the plan have a COLA adjustment? • What death benefits are paid to spouse? • How are the pension funds invested? • How are individual benefits determined?

18. Defined Contribution Plans • AKA money purchase plans, profit-sharing plans, employee stock option plans, 401 (k) plans, 403(b) plans • Common characteristics • Contributions come from both employee and employer • Typically employer matches employee’s contribution up to certain amount • Employee has more control as to how funds are invested • Most plans offer wide range of investment opportunities • Participation may be partly or wholly voluntary

19. Defined Contribution Plans • Can reduce your taxes • Your taxable income is reduced by the amount you contribute • Example: You pay $2,000 a year into your 401(k) and you are in the 28% tax bracket • Your taxable income is reduced by $2,000 a year, saving you $560 a year. So, your $2,000 retirement savings only cost $1,440. • You pay taxes on the amount you withdraw once you retire, but not until then

20. Defined Contribution Plans • All plans set a maximum contribution up to limit specified by IRS • Current limit is $11,000/year or 15% of income, whichever is less • Vesting requirements differ across employers • Typically your contributions vest immediately but several years may pass before employer’s contributions vest

21. Defined Contribution Plans • Investment Options • Many offer numerous mutual funds for you to choose from • Changing jobs • If you change jobs you may receive a lump sum comprised of • Your portion of contributions • Your employer’s portion (if vested) • Your investment returns • You should roll this amount over into a rollover IRA • If you don’t, may be subject to a 20% withholding tax + penalties • Borrowing money from your retirement plan • It’s possible and then you pay the money back to yourself with interest over a specified time period • But, the interest rate you pay yourself may be less than what you could have earned and if you leave your job or are laid off, you have only 30 days to repay or you’ll face a tax penalty

22. Individual Retirement Plans • Many individuals have their own retirement plan—the best known is the IRA • Regular IRAs • Can contribute up to $3,000 ($6,000 total if married—even if spouse doesn’t work) • Ceilings placed on the amount you can deduct (based on your income) unless you are not covered by a qualified retirement plan, then can deduct full amount (up to the limits specified above) • Even if you can’t deduct IRA contributions, earnings on IRA are still tax deferred • Can contribute to an IRA through 4/15 and still have it count on prior year’s tax return • You control where the money is invested: CDs, bonds, stocks, etc.

23. Individual Retirement Accounts • Roth IRAs • All earnings are tax deferred • Contributions are not tax deductible • But, all withdrawals are tax free • Higher income limits • Can make a full contribution as long as your AGI < $150,000/year (married) • With a regular IRA can only take a full contribution if you make < $53,000 (married) • Can start using your savings prior to age 59½ for any purpose • Can make tax and penalty-free withdrawals (if account has been opened for 5+ years) to purchase first home

24. Individual Retirement Accounts • Rollover IRAs • Differs from regular IRA in that • You can deposit your rollover funds in a lump sum, regardless of amount, but don’t mix with an existing IRA account • You generally cannot make additional contributions to a rollover IRA

25. Individual Retirement Plans • SEP Plans • Simplified employee pension plan • For small businesses with < 25 employees • Basically specialized IRA • Keogh Plans • Pension plan for self-employed people

26. Payout Options • Annuity—a series of regular, level, monthly payments, usually lasts for rest of your life • Adv: security (regular payments, can’t outlive benefits); spouse may get benefits after your death • Disadv: may not be indexed for inflation; lack of flexibility; taxes due on annuity every year • Periodic payments—installment payments of roughly equal amount over specified time period • Adv: security (regular pmts); larger payments than an annuity; may roll some payments into an IRA • Disadv: taxes due on the amount received each year (may knock you into an higher bracket); no guarantee of lifetime income; lack of flexibility

27. Payout Options • Lump sum—a cash payment of all the money in your account • Adv: total control over what is done with money; eligible for forward averaging which can reduce your taxes • Disadv: taxes due immediately; no guarantee you won’t outlive your financial resources; you may spend money too quickly • IRA rollover—lump-sum payment is deposited into special rollover IRA • Adv: investments continue to be tax-deferred; control over where money is invested; flexibility in timing and amounts withdrawn • Disadv: may pay more taxes than if lump sum withdrawal made; MUST begin regular withdrawal at 70½

28. Receiving Retirement Benefits • What is best for you may not be what works for someone else • Consult with your benefits office • Many offer retirement planning seminars

29. Choosing An Annuity • Very popular • Must consider: • Rate—is it fixed or variable? Fixed rate offers a fixed payment throughout life of annuity • Sales commission—are you charged a load fee? • Withdrawal penalties—are there any, do they decline over time? • Rates and annual fees—comparison shop • Financial strength of issuer—annuities are not federally insured; most are sold by life insurance companies • Will only receive your annuity payment if company remains in business