1. Dr. Steven M. Hays BKHS Personal Finance 1

2. Objectives  Describe the role of Social Security  Explain the difference between defined- benefit and defined-contribution retirement plans  Present the key decisions you must make regarding retirement plans  Introduce the retirement plans available for self-employed individuals 19-2

3. Objectives - continued  Describe types of individual retirement accounts  Illustrate how to estimate the savings you will have in your retirement account at the time you retire  Show how to measure the tax benefits from contributing to a retirement plan 19-3

4. Social Security  Social Security is a federal program that taxes you during your working years and uses the funds to make payments to you upon retirement  It does not provide adequate income to solely support most people 19-4

5. Social Security  Qualifying for Social Security You need to accumulate 40 credits from contributing to Social Security ○ One credit for each $780 in income per year, maximum 4 per year Social Security also available for disabled 19-5

6. Social Security Survivor’s benefits are also provided ○ A one-time income payment to the spouse ○ Monthly income payments if spouse is older than 60 or has a child under the age of 16 ○ Monthly income payments to children under age 18  Social Security Taxes Collected from both employees and employers ○ 6.2% for Social Security ○ 1.45% for Medicare 19-6

7. Social Security 19-7 Exhibit 19.1: FICA Taxes on Various Income Levels

8. Financial Planning Online: Request a Social Security Statement  Go to: http://www.ssa.gov/top10.htmlhttp://www.ssa.gov/top10.html  This Web site provides a form that you can use to request that a statement of your lifetime earnings and an estimate of your benefits be mailed to you. 19-8

9. Social Security  Retirement benefits Depends on your income and the number of years you earned income Provides about 42% of your annual income Eligible for full retirement benefits at age 65 You can earn limited income while receiving Social Security 19-9

10. Social Security  Concern about retirement benefits in the future Retirees are living longer which costs the program more in benefits The number of retirees continues to grow Many people are relying less on Social Security and establishing their own retirement programs 19-10

11. Employer-Sponsored Retirement Plans  Designed to help you save for retirement  Employees and/or employers contribute  A penalty is imposed for early withdrawal  Your contributions are tax-deferred 19-11

12. Employer-Sponsored Retirement Plans  Defined-benefit plan: an employee- sponsored retirement plan that guarantees you a specific amount of income when you retire based on your salary and years of employment Vested: having a claim to a portion of the money in an employer-sponsored retirement account that has been reserved for you upon your retirement even if you leave the company 19-12

13. Employer-Sponsored Retirement Plans  Defined-contribution plan: an employer- sponsored retirement plan that specifies guidelines under which you and/or your employer can contribute to your retirement account and that allows you to invest the funds as you wish 19-13

14. Employer-Sponsored Retirement Plans Benefits of a defined- contribution plan ○ Money contributed by employer is like extra income ○ Encourages employees to save ○ Offers tax deferred income Investing funds in your retirement account ○ Employer can usually choose from a number of different funds 19-14

15. Your Retirement Planning Decisions  Which retirement plan should you pursue? An employer-sponsored plan is usually the best choice if your employer contributes  How much to contribute? As much as you can as early as you can! How much to save? ○ How many people will you be supporting? ○ What do you expect prices to be? ○ What is your estimated life expectancy? 19-15

16. Financial Planning Online: Retirement Expense Calculator  Go to: http://moneycentral.msn.com/investor/ calcs/n_retireq/main.asp http://moneycentral.msn.com/investor/ calcs/n_retireq/main.asp  This Web site provides an estimate of your expenses at retirement based on your current salary and expenses. 19-16

17. Your Retirement Planning Decisions  How to invest your contributions? Use a diversified set of investments Consider the number of years to retirement Consider your level of risk tolerance 19-17

18. Your Retirement Planning Decisions 19-18 Exhibit 19.2: Typical Composition of a Retirement Account Portfolio

19. Your Retirement Planning Decisions 19-19 Exhibit 19.2: Typical Composition of a Retirement Account Portfolio

20. Retirement Plans Offered by Employers  401(k) plan: a defined-contribution plan that allows employees to contribute a maximum of $10,500 per year or 15 percent of their salary on a pre-tax basis Amount of contribution gradually increasing to $15,000 under Tax Relief Act of 2001 Matching contributions by some employers Tax on money withdrawn from the account ○ Tax and penalty for withdrawals before age 59½ 19-20

21. Retirement Plans Offered by Employers  Focus on Ethics: 401(k) investment alternatives Plans requiring employees to invest their 401(k) contributions in their employer’s stock is unethical These contributions should be diversified 19-21

22. Retirement Plans Offered by Employers  403-b plan: a defined-contribution plan allowing employees of non-profit organizations to invest up to $10,000 of their income on a tax-deferred basis Gradually increasing to $15,000 under Tax Relief Act of 2001 19-22

23. Retirement Plans Offered by Employers  Simplified Employee Plan (SEP): a defined-contribution plan commonly offered by firms with 1 to 10 employees or used by self-employed people Employee cannot contribute to this plan Tax and penalty for withdrawals before age 59 19-23

24. Retirement Plans Offered by Employers  SIMPLE (Savings Incentive Match Plan for Employees) Plan: a defined- contribution plan intended for firms with 100 or fewer employees Employee can contribute up to $6,000 annually and the employer can match 19-24

25. Retirement Plans Offered by Employers  Profit sharing: a defined-contribution plan in which the employer makes contributions to employee retirement accounts based on a specified formula Up to 15% of employee’s salary, maximum $24,000 per year 19-25

26. Retirement Plans Offered by Employers  Employee Stock Ownership Plan (ESOP): a retirement plan in which the employer contributes some of its own stock to the employee’s retirement account More risky because it is not diversified 19-26

27. Retirement Plans Offered by Employers  Managing your retirement account after leaving your employer Rollover IRA: an individual retirement account into which you can transfer your assets from your company retirement plan tax-free while avoiding penalties 19-27

28. Retirement Plans for Self- Employed Individuals  Keogh Plan: a retirement plan that enables self-employed individuals to contribute part of their pre-tax income to a retirement account Up to 25% to a maximum of $30,000 annually Individual determines how funds are invested 19-28

29. Retirement Plans for Self- Employed Individuals  Simplified Employee Plan (SEP) Also available for self-employed who can contribute up to 15% of annual income to a maximum of $24,000 annually 19-29

30. Individual Retirement Accounts  Traditional IRA: a retirement plan that enables individuals to invest $5,000 per year If over age 50, $6,000 per year Contributions may or may not be tax-deductible Interest earned is tax-deferred Tax and penalty on withdrawals before age 59 19-30

31. Individual Retirement Accounts  Roth IRA: a retirement plan that enables individuals who are under specific income limits to invest $5,000 per year Increases to $6000 if over age 50 Income taxed at time of contribution, but not when withdrawn 19-31

32. Individual Retirement Accounts  Comparison of the Roth IRA and Traditional IRA 19-32

33. Individual Retirement Accounts Factors that affect your choice ○ Marginal tax rates at time of contribution and withdrawal 19-33

34. Financial Planning Online: Traditional IRA or Roth IRA?  Go to: http://www.financenter.com/products/ sellingtools/calculators/ira/ http://www.financenter.com/products/ sellingtools/calculators/ira/  Click on: “Should I convert my IRA into a Roth IRA?”  This Web site provides an analysis of whether a Traditional or a Roth IRA is better suited to you. 19-34

35. Annuities  Annuity: a financial contract that provides annual payments over a specified period  Contributions taxable but gains are tax- deferred  Fixed versus variable annuities Fixed annuity: an annuity that provides a specified return on your investment, so you know exactly how much you will receive at a future time 19-35

36. Annuities Variable annuity: an annuity in which the return is based on the performance of the selected investment vehicles  Annuity fees High fees is a disadvantage of annuities Surrender charge: a fee that may be imposed on any money withdrawn from an annuity 19-36

37. Annuities Also commissions to salespeople Look for no-load annuities that do not charge commissions and have low management fees 19-37

38. Financial Planning Online: How to Build Your Retirement Plan  Go to: http://www.quicken.com/retirement/planner/ http://www.quicken.com/retirement/planner/  This Web site provides a framework for building a retirement plan based on your financial situation. 19-38

39. How Retirement Planning Fits within Your Financial Plan  Key decisions about retirement planning for your financial plan are: Should you invest in a retirement plan? How much should you invest in a retirement plan? How should you allocate investments within your retirement plan? 19-39

40. Integrating Key Concepts 19-40

41. The Big Question ?  Have you started to plan for your future? 19-41