Personal Finance Garman/Forgue Tenth Edition Chapter 17: Retirement Planning PPT slide program prepared by Amy Forgue and Ray Forgue.

Introduction A comfortable retirement takes planning: Invest early. Invest regularly. Use tax-sheltered accounts. Diversify. Copyright ©Cengage Learning. All rights reserved.

Your Next Five Years In the next five years: 1. Save continuously within a tax-sheltered employer-sponsored retirement plan at least the amount required to obtain the full matching contribution from your employer. Copyright ©Cengage Learning. All rights reserved.

Your Next Five Years 2. Start saving early in life by diversifying through mutual funds and limit company stock to no more than 10 percent of your portfolio. 3. Accept enough risk to increase the likelihood that you will have enough money in retirement. Copyright ©Cengage Learning. All rights reserved.

Your Next Five Years 4. Contribute to Roth IRA and traditional IRA accounts to supplement your employer-sponsored plans. 5. Keep your hands off your retirement money. Do not borrow it. Do not withdraw it. When changing employers, roll over the funds into the new employer’s plan or a rollover IRA account. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #1 Recognize that you are solely responsible for funding your retirement and must sacrifice some current spending and invest for your future lifestyle. Copyright ©Cengage Learning. All rights reserved. 17 - 6

Retirement Planning Is Your Responsibility Retirement: The time in life when the major sources of income changed from earned income to employer-based retirement benefits, private savings and investments, Social Security, etc. Copyright ©Cengage Learning. All rights reserved. 17 - 7

Figure 17.1: Sources of Retirement Income Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.1 Summarize how retirement planning has changed in recent years and has now become each individual’s responsibility. List the financial planning actions that individuals must take during their working life to prepare for retirement. Comment on the cost of delaying saving for retirement. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #2 Estimate your Social Security retirement income benefit. Copyright ©Cengage Learning. All rights reserved.

Understanding Your Social Security Retirement Income Benefits FICA Taxes: Social Security taxes withheld from wages to support income payments. 6.2 percent of your employment income up to maximum taxable yearly earnings (or MTYE) for retirement, disability and survivor benefits Medicare Taxes: 1.45 percent of your employment income Copyright ©Cengage Learning. All rights reserved.

Understanding Your Social Security Retirement Income Benefits How you can become qualified for Social Security benefits: Social Security Credits are earned for every $1090 (2010) in income for up to 4 per year. Being fully insured for retirement requires 40 credits. Copyright ©Cengage Learning. All rights reserved.

How to Estimate Your Social Security Retirement Benefits Indexing: adjusting earnings to account for changes in wages since the year the earnings were received. Basic Retirement Benefit (or Primary Insurance Amount) Full-benefit retirement age: 67 for those born after 1960 Copyright ©Cengage Learning. All rights reserved.

How to Estimate Your Social Security Retirement Benefits Begin receiving benefit at your full-benefit age. Begin receiving reduced benefits at a younger age; 62 is the earliest. Begin receiving larger benefits at a higher age. Copyright ©Cengage Learning. All rights reserved.

How to Estimate Your Social Security Retirement Benefits Check the accuracy of your Social Security statement. Errors can only be corrected within 3 years. Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.2 Summarize how workers become qualified for Social Security benefits. Distinguish between the benefits provided under Social Security for a worker who is fully insured and a worker who is currently insured. Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.2 How is the dollar amount of one’s Social Security benefit determined? Explain what happens if you choose to retire earlier than your full retirement age, which is probably 67. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #3 Calculate your estimated retirement savings needs in today’s dollars. Copyright ©Cengage Learning. All rights reserved.

How to Calculate Your Estimated Retirement Needs in Today’s Dollars Retirement Savings Goal (or Retirement Nest Egg) Build your nest egg during your working years and live off of it during retirement. How long will you work? How long will you live? Copyright ©Cengage Learning. All rights reserved.

How to Calculate Your Estimated Retirement Needs in Today’s Dollars Projecting your annual retirement expenses and income. Projected expenses Current nest egg Additional deposits needed Copyright ©Cengage Learning. All rights reserved. 17 - 20 20

Concept Check 17.3 List the steps in the process of estimating your retirement savings goal in today’s dollars. In the text example, what can Erik do to save more for his retirement? Give your impression of the idea of buying retirement on the “layaway plan”. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #4 Understand why you should save for retirement within tax-sheltered retirement accounts. Copyright ©Cengage Learning. All rights reserved. 17 - 22

Why Invest in Tax-Sheltered Retirement Accounts? Funds put into regular investment accounts are after-tax money. A tax-sheltered retirement accounts is one for which contributions are not subject to income taxes. Copyright ©Cengage Learning. All rights reserved.

Why Invest in Tax-Sheltered Retirement Accounts? Your contributions may be tax deductible, i.e. pretax money. Your earnings are tax-deferred. You can accumulate more money by delaying taxes. Copyright ©Cengage Learning. All rights reserved.

Why Invest in Tax-Sheltered Retirement Accounts? You have ownership and portability. You withdrawals might be tax free, i.e. withdrawals are never taxed. This is the case for “Roth” type accounts. Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.4 Distinguish between after-tax money put into investments and pretax money. Give your impression of the logic of the “net pay” numbers of participating 401(k) plan. Explain what is meant by tax-sheltered investment growth on money contributed to qualified retirement accounts. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #5 Distinguish among the types of employer-sponsored and personally established tax-sheltered retirement plans. Copyright ©Cengage Learning. All rights reserved. 17 - 27

Employer-Sponsored Retirement Plans Employer-sponsored retirement plans (or Qualified Plans) Employee retirement income security Act (or ERISA) Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans Defined-contribution retirement plan: today’s standard. A plan can be either a noncontributory plan or a contributory plan. Benefits are based on the success of the investments made with the funds. Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans Types of defined-contribution retirement plans: 401(k) Plans (with Roth versions) 403(b) Plans (with Roth versions) 457 Plans Savings Incentive Match Plan for Employees IRA (SIMPLE IRA) Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans Matching contributions: employers fully or partially match employee contributions Limits on contributions: $16,500 for 401(k), 403(b), and 457; $11,500 for SIMPLE IRAs (in 2009 with annual increase for inflation). Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans Catch-up provision: Workers over the age of 50 can contribute and extra $5000 to retirement plan. Vesting gives you rights to your benefits. Cliff vesting Graduated vesting Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans Retirement plan contribution tax credit for low-income and moderate-income savers. For singles with adjusted gross incomes of less the $25,000 and joint filers with adjusted gross incomes less than $50,000. Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans How Manage Retirement Money When Leaving an Employer Leave it Transfer it to a new employer or a rollover IRA. Take all or part and pay any taxes and penalties. Avoid the 20 Percent Withholding Rule by using a trustee-to-trustee rollover. Copyright ©Cengage Learning. All rights reserved. 17 - 34

Employer-Sponsored Retirement Plans Defined-benefit retirement plans are yesterday’s standard; A.K.A. Pension Defined-benefit plans are totally employer funded. Benefits are based on a formula using salary and years worked for the employer. Copyright ©Cengage Learning. All rights reserved.

Employer-Sponsored Retirement Plans Normal or early retirement? Disability and survivors benefits Copyright ©Cengage Learning. All rights reserved.

Additional Employer-Sponsored Plans Cash-balance plan is a hybrid plan with features of a defined-benefit plan and aspects of a defined-contribution plan. Copyright ©Cengage Learning. All rights reserved.

Additional Employer-Sponsored Plans Employee stock-ownership plan (or ESOP) Profit-sharing plan Copyright ©Cengage Learning. All rights reserved. 17 - 38 38

Withdrawing Retirement Money Early Penalty-Free Withdrawals Early retirement at age 55 with penalties waived if you agree to IRS withdrawal rate. Certain expenses for medical, college or home buying are allowed from IRA accounts. Account loans are available from certain employer-based accounts but must repaid when leaving employment to avoid penalties. Copyright ©Cengage Learning. All rights reserved. 17 - 39 39

Withdrawing Retirement Money Early Negative Impacts of Early Withdrawals Taxes must be paid (except for Roth accounts) Penalties may be assessed; 10 percent. Your investments stop growing. Copyright ©Cengage Learning. All rights reserved. 17 - 40 40

You Can Also Contribute to Personal Retirement Accounts Individual Retirement Account (or IRA) Traditional (or regular) IRA Roth IRAs Keoghs and Simplified Employee Pension-Individual Retirement Account (SEP-IRAs) Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.5 Summarize the main differences between defined-contribution and defined-benefit pension plans. Explain why defined-contribution retirement plans are called self-directed. Offer your impressions of working for an employer that offers a sizable matching contribution compared with one that does not. Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.5 List three differences between a traditional IRA and a Roth IRA. List three negative impacts of withdrawing money early from a tax-sheltered retirement account. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #6 Make use of professional investment advisors and Monte Carlo simulations when deciding on how to invest for retirement. Copyright ©Cengage Learning. All rights reserved.

Use Financial Advice and Monte Carlo Simulations When starting out, try investing in a low-fee target-date retirement fund. Use Monte Carlo simulations to help guide retirement investment decisions. Copyright ©Cengage Learning. All rights reserved.

Figure 17.2: Monte Carlo Simulation from Financial Engines Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.6 Do you visualize yourself as a “do-it-yourself” or as a “hands-off” type of investor of retirement funds? Tell why. Summarize the importance of low-cost mutual fund fees to long-term investing success. Offer some impressions of Monte Carlo simulations as a tool to use in retirement planning. Copyright ©Cengage Learning. All rights reserved.

Learning Objective #7 Describe techniques for living in retirement without running out of money. Copyright ©Cengage Learning. All rights reserved. 17 - 48

Living in Retirement Without Running Out of Money Figure out how many years your money will last in retirement and make monthly withdrawals accordingly. Buy an annuity (or immediate annuity) with some of your nest-egg and receive monthly checks. There are immediate, deferred, and variable annuities. Often offered by employers Copyright ©Cengage Learning. All rights reserved.

Table 17.4: How Long Will the Retirement Money Last? The odds your funds will last: Withdrawal Rate 20 yrs. 30 yrs. 40 yrs. 3% 99% 99% 93% 4% 99% 86% 68% 5% 93% 67% 41% 6% 74% 35% 18% Copyright ©Cengage Learning. All rights reserved.

Living in Retirement Without Running Out of Money What retirement money to spend first: Taxable Assets Tax-Deferred Assets Tax-Free Assets Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.7 Use Appendix A.4 to calculate how much could be withdrawn each year form a $900,000 retirement nest egg earning 5 percent if you wanted the nest egg to last 20 years? How much less could be withdrawn so that the nest egg lasts 25 years? Copyright ©Cengage Learning. All rights reserved.

Concept Check 17.7 Offer some positive and negative observations on the wisdom of buying an annuity with all or some of your retirement nest egg money when you retire. Copyright ©Cengage Learning. All rights reserved.

The Top 3 Financial Missteps In Retirement Planning People slip up in investing in retirement planning when they do the following: 1. Starting to save for retirement in their thirties, or worse, their forties. 2. Putting away too little money. 3. Using mutual funds with high-expense ratios for their 401(k) or IRA accounts. Copyright ©Cengage Learning. All rights reserved.

Do It NOW! Wise financial planners begin saving for retirement right away after beginning their careers. Start today by: 1. Calculating your retirement savings amount at both age 60 and 67 based on your projected income following graduation. Copyright ©Cengage Learning. All rights reserved.

Do It NOW! 2. Deciding tentatively whether you would invest retirement savings in an employer-sponsored plan or a personally established tax-sheltered retirement account. 3. Thinking about the types of mutual funds you will use to invest for retirement as mutual funds will be the primary sources available to you. Copyright ©Cengage Learning. All rights reserved.