MBAO Executive Compensation Executive Retirement Benefits Purpose of Retirement Benefits Income replacement at retirement Maintain standard of living at retirement Need about 80% of pre-retirement income from all sources Some of retirement income is not taxed such as Soc. Sec. & income from Roth IRAs Use as asset to create wealth, borrow, or form estate to leave to your heirs (children, spouse, charity).

MBAO Executive Compensation Sources of Retirement Income When you Decide to Retire you want a 3-legged stool of resources to generate retirement income 1. Social Security (10 percent or less for executives) 2. Retirement Benefits (50-60 percent) - most significant source of retirement income: –pensions (defined benefit plan) –retirement benefits (defined contribution plan) 3. Personal Savings (30-40 percent) –home equity –personal investments in stocks, bonds, vacation property

MBAO Executive Compensation Retirement Benefits: Defined Benefit Plans Features of Defined Benefit (DB) Plans Retirement benefit is known in advance based on a formula Traditional retirement plan used by large firms Employer assumes all the financial risk and makes contributions while managing them Formula based on two variables: 1. Average Salary for last 5 years (year prior to retirement) 2. Number of years of service (may need 20 or more yrs.) Examples: pensions, cash balance plans

MBAO Executive Compensation Retirement Benefits: Defined Contribution Plans Features of Defined Contribution (DC) Plans Employer contributions to plan are known But…amount of retirement income when employee retires is unknown. Employee shares risk with employer Employee takes active role in managing investment contributions - and also can keep all of the upside investment gains (not the case with DB plans). Examples: 401(k) Plan, IRAs, SEP

MBAO Executive Compensation 401(k) Plans Plan Characteristics Refers to sec. 401(k) of IRC Fastest growing retirement plan Contribution limit: 15% salary up to $10,000 per year Employer matches: 25% to 100% in most firms Plan contributions not taxed and accumulations tax deferred Distributions taken out after age 59 1/2; tax penalty of 20% for early withdrawal, except emergency Loans of up to $50 K possible; interest

MBAO Executive Compensation 401(k) Plan: Compare to taxed investment 401(k) Investment Taxed Investment before taxes $1000 $1000 after taxes (28%) $1000 $720 ‘er match (75%) $ fund gain (20%) $350 $144 taxed gains (28%) 00 $40 net gain $350 $104 Total after 1 year $2100 $824 ROI (1 year) 110% 14%

MBAO Executive Compensation 401(k) Plan Tips Start your 401(k) plan immediately, to take advantage of “miracle” of compound interest –some companies now have automatic enrollments If 20 or more years from retirement, invest aggressively in stocks If employer match is paid in company stock, sell some of the stock when vested so there is diversification of assets and reduced exposure to risk. When changing jobs, roll over money into new employer’s 401(k) if > $5K, if < $5K roll into an IRA - there are tax penalties for cashing out early.

MBAO Executive Compensation Characteristics of best 401(k) Plans Diverse Investment Choices –at least 8 investment options to choose from –employees are able to change fund allocations Asset Diversification –stocks and bonds –large and small cap stocks –domestic and international stocks –index and sector funds Limited Employer Stock Holdings –less than 10% of portfolio –limited employer stock when matching

MBAO Executive Compensation Important Considerations for 401(k) plans Invest at least up to the maximum employer match - don’t leave free money on the table Avoid loans –loss of compounding is costly –make loan only for an emergency Prevent allocation drift –reallocate contributions periodically to maintain investment within risk comfort zone

MBAO Executive Compensation IRA Plans: Traditional IRA Plan Characteristics There are both personal and employer-sponsored IRAs Contribution limit: $2,000 per person and $4,000 if joint with spouse Used by self-employed or entrepreneurs without company retirement plan or may those who have put maximum in company plan. Plan contributions not taxed and accumulations tax deferred Full pre-tax benefit limit: $30K (single), $50K (joint) AGI

MBAO Executive Compensation IRA Plans: Traditional IRA Advantages of Traditional IRAs Immediate tax savings and accumulations tax deferred A person with AGI above $40K ($60K for joint filers) can start an IRA with tax deferred interest benefits, but without tax savings on contributions. More investment choices than 401(k) plans. Disadvantages of Traditional IRAs Distributions are taxed - high income people get hit Must make min. distributions by age 70 1/2 Early withdraw (< 59 1/2) incurs tax penalty

MBAO Executive Compensation IRA Plans: Roth IRA Characteristics of Roth IRAs Amount of Contributions same as other IRAs Contributions are made with after tax money Accumulations are not taxed Distributions are not taxed Attractive investment for people who have put maximum in 401(k) plan At retirement non-taxed distributions allow retiree to have tax diversification from other retirement income that is taxed - so a lower income tax bracket is possible.

MBAO Executive Compensation IRA Plans: Roth IRA Advantages of Roth IRAs Singles who earn up to $95K get full benefits and up to $110K partial ($150K & $160K for joint). Can continue making contributions after age 70 1/2 which is not possible with traditional IRA Not required to take min. distributions age 70 1/2 Can convert traditional to a Roth IRA Past 59 1/2 take lump sum distributions w/o tax Disadvantages of Roth IRAs Contributions are taxed - may not be beneficial if expect to be in low tax bracket at retirement. 5 year holding period requirement

MBAO Executive Compensation Simplified Employee Pensions (SEPs) Plan Characteristics An individual retirement account or individual retirement annuity for an employee to which the employer makes tax-deductible contributions. For self-employed or employees of small business without a retirement plan. Similar tax rules as IRA with no tax on contributions, tax deferred accumulations and taxed on distributions after age 59 1/2

MBAO Executive Compensation Simplified Employee Pensions (SEPs) Plan Characteristics The employer’s contribution limit for an employee is the lesser of 15% of employee’s annual salary or $30,000. Employee may contribute an additional $2,000 to a personal IRA while participant in an SEP. SEP distributions taxed similar to IRA rules.

MBAO Executive Compensation Simplified Employee Pensions (SEPs) SEP Advantages Minimal amount of record keeping to start and maintain the plan. Less need for lawyers, etc. Employer can be flexible in providing contributions, compared to qualified pensions. Employees choose own investments in SEP. SEP Disadvantages More employees such as part-time must participate than qualified pension plans. Employees must be fully vested at all time, which is not the case with qualified pensions.