1. CHAPTER 13 Basic Structure of Retirement Income Chapter 13: Retirement Income1

2. INTRODUCTION  Argument for planning early for retirement is compelling  Nationwide Financials Survey (2011): Americans are becoming increasingly concerned about retirement as the economic downturn stymied income growth and wreaked havoc on investments.  Wells Fargo Retirement Survey (2010): 72 percent of middle-class Americans between the ages of 25 and 69 expect to work through their retirement.  Gallop Poll (2011): The poll reveals that 66 percent of Americans ranked not having enough money for retirement as their top financial concern.  Wells Fargo-Harris Survey (2010): Survey reveals a disturbing gap between savings needs and savings rates.  This gloomy picture dims further by recognizing that pensions and Social Security might not provide sufficient cushion for retirement Chapter 13: Retirement Income2

3. INTRODUCTION (Contd.)  Planning for retirement involves four steps: (1) Estimate pre-retirement expenses (2) Determine desired standard of living based on (1) monthly/annual retirement expenses needed (3) Estimate total expected income during retirement from all sources, including government-sponsored plans, corporate & personal retirement plans, personal savings, and employment (4) Take appropriate steps now if expected income falls short of expected expenditure needs  Key sources of retirement income:  Government Sponsored Plans  Corporate Retirement Plans  Personal Retirement Plans  Personal Taxable Investments  Employment During Retirement Chapter 13: Retirement Income3

4. PLANNING FOR RETIREMENT Figure 13-1 Planning for Retirement Chapter 13: Retirement Income4

5. RETIREMENT PLANS: SOCIAL SECURITY Chapter 13: Retirement Income5

6. SOCIAL SECURITY: FULL RETIREMENT AGE Chapter 13: Retirement Income6

7. Taxation of Social Security Benefits Chapter 13: Retirement Income7

8. Types of Benefits  Retirement  Normal retirement age 67 if born after 1960  If work longer benefits raised  Minimum retirement age is 62  Lowers benefits (permanent)  Benefits extend to spouse and children (max 50%)  Survivors Benefits  Children and spouse amount based on credits Chapter 13: Retirement Income 8

9. Types of Benefits  Disability  Based on inability to work (long-term)  Has an impairment that will last at least 12 months or result in death  Could last for a lifetime  Private usually only lasts until retirement age  Medicare (Health insurance program)  Part A - hospital and nursing care  Part B – medical insurance (premium)  Part C – Medicare advantage (choose heath plans)  Part D – Drug plan Chapter 13: Retirement Income 9

10. CORPORATE RETIREMENT PLANS  GENERAL DISCUSSION  These plans, known as qualified plans, provide excellent means of accumulating wealth on a tax- deferred basis.  Corporate retirement plans offer tax advantages both to employer and employee.  HCE – highly compensated employees  NHCE – non-highly compensated employees Chapter 13: Retirement Income10

11. Major Categories of Corporate Retirement Plans Figure 13-3 Major Categories of Corporate Retirement Plans Chapter 13: Retirement Income11

12. CORPORATE RETIREMENT PLANS  SPECIFIC REQUIREMENTS  PARTICIPATION REQUIREMENTS  21 years old and 1 years employment must be covered  If have immediate vesting 2 years employment may be required  COVERAGE REQUIREMENTS  Ratio Percentage Test  Cover a percentage of NHCE is at least 70% of the HCE covered  Average Benefits Test  Must benefit NHCE as a percentage of compensation compared to the HCE  Minimum Participation Test  Only for defined benefit plans  Outlines how many people must participate Chapter 13: Retirement Income12

13. CORPORATE RETIREMENT PLANS (Contd.)  VESTING REQUIREMENTS  How long must you work until company contributions belong to the employee  Full vesting at end of 5 or graduated (20% per year)  Immediate vesting can also be provided  FUNDING REQUIREMENTS  Rules set to determine how much and when company is required to place funds in the plan  PLAN INVESTMENT RULES Federal guidelines indicate that investments should be sufficiently :  Liquid; Diversified; and conservative w/o undue risk Chapter 13: Retirement Income13

14. TYPES OF CORPORATE RETIREMENT PLANS Major Categories of Qualified Plans:  Defined Contribution Plans  Employee contribution usually a percentage  Limits for different plans  Employer contribution also a percentage of compensation  Rules applied if an employee terminates before vested  Defined Benefit Plans  Amount contributed based on forecasts of future benefits to be paid out, current balances, and investment returns  Target Benefit Plans: a hybrid of a money purchase (form of defined contribution) and defined benefit plans Chapter 13: Retirement Income14

15. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Money Purchase Pension Plan  Employer contribution  Percentage or flat amount  Maximum contribution 100% of income or 50,000 (2012)  Plans gains and losses allocated to participants  Forfeitures may be reallocated  Investments determined by trustee of the plan Chapter 13: Retirement Income15

16. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Simple Retirement Plan  100 or fewer employees  Looks like a 401k plan (max 12,000) (2013)  No discrimination rules problems if  Employer matches up to 3 percent  Or makes non-matching 2 percent contributions Chapter 13: Retirement Income16

17. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Simplified Employee Pension (SEP) Plan  Employers make contributions into IRA  Very little paperwork  Contribution must be made according to the formula maximum 51,000 or 25% of income (if lower)  IRA rules followed except for the contribution limits  Can still have individual IRA outside the work plan Chapter 13: Retirement Income17

18. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Profit Sharing Plan  Formula determines contribution  Can still make contributions if no profit  Limited to 25% of compensation to ALL eligible employees  Vesting rules apply  If employee leaves before vesting; the company’s contribution to the leaving employee’s plan can be  1) used to reduce future contributions  2) split between the remaining employees Chapter 13: Retirement Income18

19. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  401(k) Plan  Company and employee contributions  17,500 employee contribution (5,500 if over 50)  Company can match but total combined contribution cannot exceed 45,000  Individual 401k plans are available for self-employed without employees  403B plans are very similar except a non-profit company  Open to charitable institutions (501c)  Limited same as 401k  Much like a 401k Chapter 13: Retirement Income19

20. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Stock Bonus Plan  Profit sharing except employer’s contribution can be stock or cash  Thrift plan  Hybrid of profit sharing and stock bonus plan  ESOP  Invests primarily in company stock Chapter 13: Retirement Income20

21. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Defined Benefit Plans  A qualified employee pension plan that guarantees specified benefit level at retirement  Reward long-term employees with larger retirement benefits  First establishes the benefit employer wants employee to receive upon retirement, then contributions are set at the level necessary to achieve targeted benefits  Formula consists of either a flat dollar amount or a flat percentage of earnings  Defined Benefit Plans include:  Fixed benefit plans in which all employees receive the same benefits  Flat benefit plans where benefit is % of salary  Unit benefit plans in which benefit depends on income (optional) and time of service Chapter 13: Retirement Income21

22. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Age-Weighted Profit Sharing Plans  Offer some of the best features of profit sharing and defined benefits plans  Are cheaper than traditional defined benefit plans  Are subject to less rigorous IRS regulatory requirements than those for defined benefit plans Chapter 13: Retirement Income22

23. TYPES OF CORPORATE RETIREMENT PLANS (Contd.)  Age-Weighted Profit Sharing Plan must meet all the requirements of a regular profit sharing plan: 1. Maximum deduction is 25% (2013) of covered payroll 2. Each year employer maintains discretion over making contributions to the plan 3. Maximum individual allocation for any one participant is $50,000 (2013) or 100% of salary, whichever is less 4. Top heavy plans must satisfy the 3% top-heavy minimum requirement for all non-key employees 5. Forfeitures from non-vested accounts are allowed to be reallocated, or they may be used to reduce future contributions 6. Investment earnings are allocated to participant accounts Chapter 13: Retirement Income23

24. Age-Weighted Profit Sharing Plans (Contd.) Chapter 13: Retirement Income24

25. Choice of Handling Lump-Sum Distribution Chapter 13: Retirement Income25

26. PERSONAL RETIREMENT PLANS INDIVIDUAL RETIREMENT ACCOUNT (IRA)  An Overview:  Deductibility Provisions Summarized in Table 13-8  Regular IRA vs. Roth IRA  Raised Contribution Limits  Long-Term Accumulation  Deductible versus Nondeductible Contributions  Types of IRAs  Individual Retirement Plan  Individual Retirement Annuity Plan  Rollover versus Transfer Chapter 13: Retirement Income26

27. PERSONAL RETIREMENT PLANS INDIVIDUAL RETIREMENT ACCOUNT (IRA)  Deductible versus Nondeductible Contributions  Before tax  Get tax deferral of earnings  Investment principal can be taken after certain rules met  After-tax contributions  Tax deferral  All withdrawals taxed  Contributions  5,500 (indexed to inflation), or gross income  1,000 catch up if over 50 Chapter 13: Retirement Income27

28. PERSONAL RETIREMENT PLANS INDIVIDUAL RETIREMENT ACCOUNT (IRA)  Types of IRAs  Traditional IRA  Taxable withdrawals  Tax deductible  Roth IRA  Withdrawals not taxed  After-tax contribution  Rollover versus Transfer  Converting an account such as a 401k from a previous employer  Technically rollover goes through investor  Transfers are the prudent method of moving the assets Chapter 13: Retirement Income28

29. DEDUCTIBILITY OF IRA Chapter 13: Retirement Income29

30. IRA: Before versus After-Tax Contribution Chapter 13: Retirement Income30 This represents the taxes paid in the beginning. An opportunity cost. However, the actual dollars invested would be the same. The end balances would be the same.