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CHAPTER 14: MEETING RETIREMENT GOALS. Retirement Planning. Is this you?. Pitfalls in Retirement Planning. Starting too late. Putting away too little. Investing too conservatively (especially when you are younger). 4 Factors to Consider in Retirement Planning. What do you want to do?
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Retirement Planning Is this you?
Pitfalls in Retirement Planning • Starting too late. • Putting away too little. • Investing too conservatively (especially when you are younger).
4 Factors to Consider in Retirement Planning • What do you want to do? • Expected standard of living. • Proposed level of income • Special activities/projects
Why has the Need for Retirement Planning Increased? • Because of the uncertainty of inflation • Uncertainty in the stock market
Retirement Planning • At what age do you want to retire? • How much money will you need? • Start early in your career to devote money toward your retirement goals. 1. Set Your Goals:
2. Estimate Your Needs: • Determine household expenditures. • Estimate income. • Consider the effects of inflation. • Decide how you will provide for the difference between income and needs.
3. Establish Investment Program: • Create systematic savings plan. • Identify appropriate investment vehicles. • Consider tax implications. • Develop investment plan. • Use the Internet for help. • Dave Ramsey
Sources of Retirement Income Government still provides the largest Portion right now.
Social Security • Benefits are provided by payroll taxes you and your employer pay (you pay both halves if you are self-employed). • Amount of benefits may be insufficient by the time you retire. • Think of it as an insurance system rather than a retirement plan.
Why SS may be in trouble: • The number of people retiring is increasing. • Eventually more money may be flowing out of the system than is flowing in.
When are you eligible for benefits? • Normal retirement age is being pushed back—you will probably have to be 67. • You must have been paying in for at least 40 quarters, or 10 years. • If you retire early (age 62), you receive a lower percentage of your total benefits. • If you retire later (age 70), you receive an increased benefit.
SS Options for 2-Income Family at Retirement • Take the full benefits to which each is entitled from his or her account • Take the husband and wife benefits of the higher-paid spouse (together they receive 1.5 shares of the higher benefit)
What are the benefits? • Old-age benefits (traditional SS retirement benefits). • Survivor's benefits for spouses who are age 60 or older or who have a dependent child. • Survivor's benefits for dependent children.
SS Retirement Benefits • Employment during retirement may cause benefits to be reduced if SS recipient is under age 66 and still gainfully employed • For those age 67 or older who work, SS benefits are not reduced • “Unearned income” does not affect SS benefits. (Ex: investment income) • SS benefits are income taxable if your annual income exceeds $25,000 if single ($32,000 for married filing jointly).
Personal Earnings and Benefit Estimate Statement from Social Security • It shows what benefits you can expect under three scenarios: • if you retire at age 62 and receive 80% of the full benefit (or less, depending on your age) • the full benefit at age 65 to 67 (depending on your birth year), • the increased benefit that’s available if you delay retirement until age 70.
Annual Increases in the Social Security Benefit Check • Tied to current cost of living
Social Security & Retirement Planning • Social Security should be viewed as a foundation for your retirement income. • It is insufficient to allow a worker and spouse to maintain their present standard of living.
Pension PlansandRetirement Programs • Employer-sponsored retirement programs • Self-directed retirement programs
Employer-Sponsored Programs: • Participation requirements— years of service, minimum age, level of earnings, employment classification. • Contributions— noncontributory (employer pays all) or contributory (cost shared by employer & employee). • Vesting— acquiring ownership • cliff vesting (fully vested after 3 years) • graded schedule (vesting takes place gradually over the first 6 years). • Retirement age— usually age 65 but could be after set number of years (30 or 35). • Qualifying— does it qualify for tax deductibility?
Defined Benefit vs. Defined Contribution Plans • Defined Contribution: company guarantees a contribution, but not a return on the contribution or a retirement benefit; retirement benefit is dependent on investment returns. • Defined Benefit: company guarantees the benefit in retirement despite good or bad performance of the pension fund; retirement benefit based on years of service, amount of total earnings, or set at a flat amount.
Cash Balance Plans: • Each employee has own account. • Employer contributes certain amount to account and controls investment. • Employer guarantees minimum return or greater on account. • When employees leave a firm, they can roll their account into their new employer’s cash balance plans or into an IRA.
Qualified Pension Plans: • Employer’s contribution is tax deductible. • Employees do not have to include these payments as part of their taxable income until the benefits are actually received. • Employees can shelter his or her contributions from taxes. • Investment income is allowed to accumulate tax free.
Supplemental Plans: Allow employees to increase retirement funds. These plans are often voluntary, and contributions may be tax deductible. • Profit-sharing plans— employees benefit from company's earnings. • Thrift and savings plans— employer contributes to employee's fund. Employee contributions NOT deductible. • Salary reduction plans— employee contributes part of salary; contributions tax deductible; employer may also contribute as in a 401(k), 457, or 403(b).
Self-Directed Retirement Programs: Allow individuals and the self-employed to set up tax-deferred retirement plans for themselves and their employees. • Keogh Plans— for professionals or small business owners and employees. • SEP Plans— for professionals or small business owners with few or no employees; simple to administer. • IRAs— for any working American; other self-directed plans may allow greater contributions.
Types of IRAs: Each year, you must EARN at least as much as you contribute to an IRA. • Traditional Tax-Deductible IRA— for those with no employer-sponsored plan or with incomes below a certain level. • Traditional Non-Deductible IRA— for those with an employer-sponsored plan and incomes over a certain level. • Roth IRA— contributions not deductible; for those with incomes below a much higher level, regardless of employer-sponsored plans.
Advantages of Roth IRA • It is funded with after tax dollars. • It allows interest or dividends to accrue tax free. • It permits you to withdraw your contribution at any time. • It provides for tax-free earnings if you hold the account 5 years and are 59 1/2 at withdrawal.
More on IRAs: • An IRA is not an investment; it is a tax-sheltered account. A variety of types of investments (ex: bank CDs, mutual funds) can be held in an IRA account. • Returns on your IRA depend on your choice of investments.
For Qualified Retirement Plans in General : • Contributions grow tax free. • If contributions were initially tax deductible, money taxed as current income when withdrawn. • In general, you must be 59 1/2 to start taking distributions. • Early withdrawals are subject to a 10% penalty plus income taxes. • When moving accounts, have transfer made directly from one custodian to another.
Annuities • Tax-sheltered investment vehicles administered by life insurance companies. • An agreement to make contributions now in return for a series of payments later. • Contributions NOT tax deductible.
Before Retirement: • Accumulation Period— annuitant purchases annuity by paying premiums into the account. During Retirement: • Distribution Period— insurance company makes payments to annuitant. Portion not returned to annuitant prior to death goes to beneficiaries.
Classification of Annuities: • Single Premium vs. Installments— one large lump-sum payment or a series of payments to purchase the annuity. • Immediate vs. Deferred— begin receiving payments immediately or wait to receive payments after purchasing annuity. • Fixed vs. Variable— investment grows at a low guaranteed fixed rate or at a presumably higher variable market-based rate with no guarantee of return.
Common Disbursement Options: • Life annuity with no refund— payments made for life of annuitant; nothing to beneficiaries. • Guaranteed minimum annuity— at least a total minimum amount will be paid out; beneficiaries receive any remainder. • Annuity certain— payments made for a set number of years and cease, regardless of life span of annuitant.
Fixed versus Variable Annuity • Fixed-rate annuity─ Annuity in which insurance company agrees to pay guaranteed rate of interest on your money. • Variable annuity─ Annuity in which monthly income from the policy varies based on insurer’s actual investment experience.
Remember: • Annuities are life insurance products, which may mean higher yearly fees plus surrender charges. • Annuities are only as good as the financial strength of the companies which issue them. • Retirement accounts are already tax sheltered. • Withdrawals made before age 59 1/2 are subject to 10% penalty and income taxes. • Annuity should be long-term investment.
Annuities may be an attractive means for higher income individuals who have fully funded their retirement accounts to tax shelter even more money.