1. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. 18-1 C HAPTER 18 Personal Finance Retirement Planning Kapoor Dlabay Hughes 6e

2. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Misconceptions About Retirement Planning My expenses will drop when I retire. My retirement will only last 15 years. I can depend on Social Security and my company pension to pay for my basic living expenses. My pension amount will keep pace with inflation. There’s plenty of time for me to start saving for retirement. Saving just a little bit won’t help. 18-2

3. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. The Importance of Starting Early To take advantage of the time value of money.  If from age 25 to 65 you invest $300 a month (9%) at age 65 you’ll have 1.4 million in your retirement fund.  Wait ten years until age 35 to start and you’ll have about $550,000.  Wait twenty years until age 45 and you’ll have only $201,000 at age 65. 18-3

4. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Why Think About Retirement Planning Now? People are spending more years (16-20) in retirement. A private pension and Social Security are most often insufficient to cover the cost of living. Inflation may diminish the purchasing power of your retirement savings. 18-4

5. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Review Your Retirement Assets Housing.  If owned, probably your biggest single asset.  If large equity, reverse annuity mortgage. Life insurance cash value can be converted into an annuity. Other investments, such as stocks and bonds. Assets after divorce.  Pension benefits are considered a marital asset to be divided. 18-5

6. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Estimating Retirement Living Expenses Spending patterns and where and how you live will probably change. Some expenses may go down or stop.  Work expenses - gas, lunches out.  Clothing expenses - fewer and more casual.  Housing expenses - house may be paid off, but taxes and insurance may go up.  Federal income taxes will probably be lower. 18-6

7. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Estimating Retirement Living Expenses Other expenses may go up.  Life and health insurance unless your employer continues to pay them.  Medical expenses increase with age.  Expenses for leisure activities.  Gifts and contributions. Inflation will raise the amount you need to cover your expenses over your probable 16- 20 years in retirement. (continued) 18-7

8. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. How an “Average” Older (65+) Household Spends its Money Food Medical Housing Transportation Clothing Contributions Insurance and other Entertainment 32.5% 11.3% 16.3% 15.4% 4.9% 5.7% 7.7 % 6.2% U.S. Bureau of Labor Statistics 18-8

9. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Planning Your Retirement Housing Think about where you want to live. Consider the cost of living and taxes. Type of housing as needs change.  Staying in their present home is what most people prefer.  Universal design is a home built to allow for potential physical limitations.  If not built using universal design, home may need to be retrofitted.  Continuing care retirement community provide increasing levels of care. 18-9

10. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Avoid Retirement Housing Traps If you plan to move when you retire…  Write the local Chamber of commerce to learn about taxes and the economic profile.  Check on state income and sales taxes and taxes on pension income.  Subscribe to a local Sunday paper.  Estimate what your utility costs would be in the area.  Rent for awhile instead of buying immediately. 18-10

11. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Planning Your Retirement Income Most widely used source of retirement income, covering 97% of U.S. workers. Meant to be part of your retirement income, but not the sole source. Check the Earnings & Benefit statement you receive each year. Full retirement benefits at age 65 to age 67, depending on the year you were born. Social Security 18-11

12. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Planning Your Retirement Income Up to 85% of your benefit may be subject to federal income tax depending on your other sources of income, such as interest income. Cost of living adjustment (COLA) each year. Spouse's benefit = 1/2 worker’s benefit. Workers’ confidence in Social Security paying them benefits when they retire is declining. Social Security (continued) 18-12

13. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Money-purchase pension plans - Percent of your earning are set aside. Stock bonus plans - Employer’s contribution is used to buy stock in your company for you. Profit-sharing plans - Employer’s contribution depends on the company’s profits. Salary reduction or 401(k); 403(b) plans...  Employer makes non-taxable contributions.  Employee contributions are tax-deferred. Planning Your Retirement Income 18-13 Employer Pension Plans - Defined Contribution

14. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Planning Your Retirement Income Employer will pay you a certain amount per month when you retire based on your pre-retirement salary and number of years of service. Employer makes the investment decisions for your and their contribution, but your benefit amount stays the same regardless of how the investments perform. 18-14 Employer Pension Plans - Defined Benefit (continued)

15. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Pension Plan Portability and Vesting Portability allows you to carry earned benefits from one employer’s pension plan to another’s when you change jobs. Vesting means you have worked for an employer long enough (3-5 years) to get a pension benefit, even if you take a position with another employer. When you leave a job you can cash in your pension, have the employer keep the funds so you will get a future pension from them, or take the funds to invest in a pension with your new employer if your pension is portable. 18-15

16. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Individual Retirement Accounts (IRA) The most popular personal retirement plan. Regular or traditional IRA.  If you meet income guidelines, money invested is taken out of your paycheck before income and Social Security taxes are computed.  You can contribute up to $2,000 per year.  The interest accumulates tax free until you start taking it out.  You pay taxes on the money as you withdraw it once you are retired or by age 70 1/2. 18-16

17. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Individual Retirement Accounts Roth IRAs.  Contributions are not tax deductible, but earnings accumulate tax free.  You can contribute up to $2,000 per year if you are single and have an AGI of $95,000 or less or $150,000 if you are filing jointly.  After five years, up to $10,000 can be used as a down payment on a first-home purchase penalty-free and tax-free. Rollover IRAs allow you transfer taxable distributions of a retirement plan into an IRA. 18-17

18. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. You decide where your money is invested. Many people put IRA money in a savings account or CD rather than thinking about their options to invest for growth. Stocks, bonds and mutual funds are options for long term growth. A KEOGH is a pension plan developed for self-employed people, and their employees. Individual Retirement Accounts 18-18

19. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. What is an Annuity? An annuity is a life insurance product to provide a guaranteed income.  Annuity options include income for a set numbers of years, for as long as you live, or for as long as you and your partner lives if he or she outlives you.  The amount you get is based on which of the above options you pick, how much you have contributed, and how you have your annuity premiums invested. 18-19

20. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Advantages of Tax-Deferred Annuities Contributions and interest earned are tax deferred. You pay taxes on the annuity dollars and interest as you withdraw them after you retire. When you retire you will likely be in a lower income tax bracket. 18-20

21. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Anticipated Sources of Retirement Income Social Security Administration, 1997 Social Security Pension Part-time work Spouse's pension Savings 12% 27% Other 9% 401(k) 7% 7% 18% IRA 8% Home equity 5% 7% 18-21

22. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Living on Your Retirement Income Estimate your income at retirement from pensions and Social Security. Together, your pension and Social Security will cover about 60% of retirement income needs. Determine how much you will need in investments to supply the other 40%. Develop a plan to accumulate this amount in assets. Monitor your investments. Take advantage of all tax savings retirees receive. Develop a spending plan for retirement. 18-22

23. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2001. All Rights Reserved. Living on Your Retirement Income Retirees get a variety of tax savings. Fewer senior discounts as boomers retire. Working during “retirement.” Invest some of your retirement income for growth to allow for inflation and increased health care costs. Consider 60% stocks and 40% bonds. Dip into savings with caution, since you do not know how long you will live. 18-23