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Chapter 16

Chapter 16. Retirement Planning. Learning Objectives. Understand the changing nature of retirement planning. Set up a retirement plan. Contribute to a tax-favored retirement plan to help fund your retirement. Learning Objectives. Choose how your retirement benefits are paid out to you.

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Chapter 16

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  1. Chapter 16 Retirement Planning

  2. Learning Objectives • Understand the changing nature of retirement planning. • Set up a retirement plan. • Contribute to a tax-favored retirement plan to help fund your retirement.

  3. Learning Objectives • Choose how your retirement benefits are paid out to you. • Put together a retirement plan and effectively monitor it.

  4. Introduction • Today, you’ve got to come up with retirements funds by yourself. • Despite Social Security reform proposals, there might not be Social Security when you retire. • Need to know about Social Security, employer-funded pensions, and current retirement plans.

  5. Social Security • Primary source of retirement income for many senior citizens. • Younger workers who won’t retire for another 40 years, Social Security may no longer be there.

  6. Financing Social Security • FICA taxes paid today are providing benefits for today’s retirees. • The money you pay is not being saved up and invested in an account for you. • Changes will be necessary, possibly increasing the retirement age or limiting benefits for the wealthy.

  7. Eligibility • 95% of Americans are covered. • Pay into system to be eligible and receive credits. • In 2008, earned 1 credit for each $1,050 in earnings up to a maximum of 4 credits per year. • With 40 credits, eligible for retirement, disability, and survivor benefits.

  8. Retirement Benefits • Benefits formula—replace 42% of average earnings based on number of earnings years, average level of earnings, adjustments for inflation, income brackets. • Full benefits at the “full” retirement age. • Reduced benefits at 62 • Increased benefits if you delay retirement.

  9. Table 16.1

  10. Figure 16.1

  11. Disability and Survivor Benefits • Provided through mandatory Social Security insurance program. • Protection for those with impairment that keeps them from work for at least 1 year. • Monthly survivor benefits when breadwinner dies. • One-time death benefit for funeral costs.

  12. Defined-Benefit Plans • Traditional pension plan where you receive “defined” pension payout at retirement. • Noncontributory retirement plan • Contributory retirement plan

  13. Defined-Benefit Plans • Portability • Vested • Funded pension plan • Unfunded pension plan

  14. Cash-Balance Plans: The Latest Twist in Defined-Benefit Plans • Workers are credited with a percentage of their pay each year, plus a predetermined rate of interest. • Employers contribute a percentage of your salary each year into an account which grows at 30-year Treasury bond rate. • Benefits easier to track and portable.

  15. Plan Now, Retire Later • Step 1: Set Goals • How costly a lifestyle will you lead? • Do you want to live like a king? • Do you have costly medical conditions? • Will you relocate or travel? • Do you want to live in your own home or retirement community. • Decide on the time frame for achieving your goals.

  16. Figure 16.2

  17. Plan Now, Retire Later • Step 2: Estimate How Much You Will Need • Turn your goals into dollars by estimating how much you will need. • Begin with 70-80% of current living expenses to calculate the cost to support yourself in retirement. • Don’t forget about paying taxes.

  18. Table 16.2

  19. Figure 16.3

  20. Plan Now, Retire Later • Step 3: Estimate Income at Retirement • Once you know how much you need, figure out how much you’ll have. • Estimate Social Security benefits and determine what your pension will pay.

  21. Plan Now, Retire Later • Step 4: Calculate the (Annual) Inflation-Adjusted Shortfall • Compare the retirement income needed with the retirement income you’ll have.

  22. Plan Now, Retire Later • Step 5: Calculate How Much YouNeed to Cover This Shortfall • Know your annual shortfall in your retirement funding. • Know how much must be saved by retirement to fund this shortfall.

  23. Plan Now, Retire Later • Step 6: Determine How Much You Must Save Annually Between Now and Retirement • Put money away little by little, year by year. • Use online retirement planning websites

  24. Table 16.3

  25. Plan Now, Retire Later • What Plan Is Best For You? • Most plans are tax-deferred. • Contributions can be made on fully or partially tax-deductible basis. • Earn compound interest on non-taxed contributions and earnings. • Taxed when you withdraw funds.

  26. Figure 16.4

  27. Defined-Contribution Plan • You and employer or your employer alone contributes directly to a retirement account set aside for you. • A savings account for retirement.

  28. Defined-Contribution Plans • Profit-Sharing Plans • Money Purchase Plan • Thrift and Savings Plan • Employee Stock Ownership Plan (ESOP) • 401 (k) Plan

  29. Defined-Contribution Plans • How much can you contribute? • Limits on the rise. • $15,500 for 401(k) and 403(b) plans in 2008 rises annually by $500 with inflation. • “Catch up” of additional $5,000 (also indexed for inflation) for those over 50.

  30. Retirement Plans for theSelf-Employed and Small Business Employees • Keogh Plan or Self-Employed Retirement Plan • Simplified Employee Pension Plan (SEP-IRA) • Savings Incentive Match Plan for Employees or SIMPLE plan

  31. Individual Retirement Arrangements (IRAs) • Traditional IRA • Roth IRA • Coverdell Education Savings Account (known as Education IRA)

  32. Traditional IRAs • Tax advantaged—contribution may or may not be tax-deductible depending on individual’s level of income and whether he/she, or spouse, is covered by a company retirement plan. • Restrictions on timing and amount of withdrawals but can rollover a distribution. • Saver’s tax credit

  33. The Roth IRA • Contributions are not tax deductible but made out of after-tax income. • Money grows tax free and withdrawals are tax free. • No withdrawal restrictions or tax penalty like traditional IRA but can also rollover.

  34. Traditional Versus Roth IRA: Which is Best for You? • You end up with the same amount to spend at retirement, if both are taxed at the same rate. • Choose the Roth IRA if you can pay your taxes ahead of time.

  35. Saving for College: The Coverdell Education Savings Accounts (ESA) • Works like a Roth IRA, except contributions are limited to $2000 annually per child under 18. • Income limits begin at $95,000 for singles, and $190,000 for couples. • Earnings are tax-free and no taxes on withdrawals to pay for education.

  36. Saving for College: 529 Plans • Tax-advantaged savings plan used for college and graduate school. • Contribute up to $250,000, grows tax-free. • Plans are sponsored by individual states, open to all applicants regardless of where they reside. • Invest directly or through financial advisor.

  37. Facing Retirement—The Payout • Plan ahead before you decide how you receive a payout. • Look at all your retirement plan payouts together—may want some in lump sum, others as annuity. • Use diversification and time dimension of risk when deciding what to do with funds.

  38. An Annuity, or Lifetime Payments • Single Life Annuity • An Annuity for Life or a “Certain Period” • Joint and Survivor Annuity • A Lump-Sum Payment

  39. Table 16.4

  40. Tax Treatment of Distributions • Annuity payouts are generally taxed as normal income. • Can pay all taxes at one with lump sum or have the distribution “rolled over” into an IRA or other qualified plan. • With rollover can avoid paying taxes on the distribution while the funds continue to grow on a tax-deferred basis.

  41. Putting a Plan Togetherand Monitoring It • Most people rely on retirement savings from a combination of different plans. • Start with seven steps. • Invest maximum allowed in tax-sheltered plans according to your investment time horizon. • Monitor before and after retirement.

  42. Figure 16.5

  43. Saving for Retirement—Let’s Postpone Starting for One Year • One year delay can cost you a lot—almost $150,000. • Only end up with more when you begin saving for retirement earlier.

  44. Figure 16.6

  45. Summary • Social Security benefits are determined by number of years of earnings, the average level of earning, an adjustment for inflation. • Funding retirement needs follows a seven-step process from setting goals to putting the plan in place and saving.

  46. Summary • Tax-favored retirement plans can be employer-sponsored, for self-employed, or individual retirement accounts—where contributions and earnings are not taxed. • Retirement benefits can be received as a lump sum, annuity, or combination. • Monitor retirement saving before and after you retire for new, unexpected changes.

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