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CHAPTER 14 Retirement Planning: Concepts and Strategies Chapter 14: Retirement Planning1
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INTRODUCTION Americans have relied on the venerable three legged stool to provide for their retirement: Social Security Benefits Private Pensions Personal Savings Many factors currently threaten the stability of this stool: Longer Lives Possible Reduction of Social Security Benefits Doubtful Viability of Many Corporate Plans Need for Increased reliance on private resources is the obvious result Chapter 14: Retirement Planning2
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INTRODUCTION (Contd.) In retirement planning: Individuals first define their goals for quality of life after retirement Next, they measure their ability to meet their goals, and develop strategies for improving their performance Finally, success in retirement planning is assured if the individual is able to retire at the desired retirement age with the expected level of income Chapter 14: Retirement Planning3
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RETIREMENT BUDGET Retirement Expenditure Analysis Analyze client’s current expenditures (Table 14-1 provides example for a hypothetical couple) Following approaches can be used to arrive at retirement budgets One approach applies the accepted rule of thumb that a retiree is likely to spend 60% or 70% of the pre- retirement expenditure level A better approach is to divide fixed and flexible expenditures into several key categories and encourage the client to estimate the retirement expenditure in each category Chapter 14: Retirement Planning4
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RETIREMENT BUDGET (Contd.) Retirement Income Potential Shortfall Analytical framework for calculating savings required for retirement is presented in Table 14-2. Strategies to solve the potential shortfall problem can be divided into three categories: 1. Tax-Advantaged Investment Planning 2. Savings Planning 3. Asset Repositioning Planning The Potential Surplus Chapter 14: Retirement Planning5
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Retirement Income Needs Analysis Figure 14-1 Retirement Income Needs Analysis Chapter 14: Retirement Planning6
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Process Determine future income need Determine amount of funds needed to cover income need Forecast retirement information 1) What do I need to invest to get the amount 2) Given my current program, what return do I need to achieve my goals 7
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Determine future income need Use the 60 – 70% of gross rule (+ or -) Need to estimate life span; return during retirement; year of retirement Assume taxes same in retirement as now DOES THIS SEEM LIKE A FAIR ASSUMPTION??? 8
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CURRENT EARN 75,000 GROSS; AGE 25; RETIRE AT AGE 60; INFLATION 4%; ESTIMATE WILL NEED 75% OF INCOME DURING RETIREMENT 9 AMOUNT NEEDED ANNUALLY TO LIVE DURING RETIREMENT AT SAME LIFESTYLE
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Determine amount of funds needed to cover income need ESTIMATE THAT WILL LIVE TO BE 80 YEARS OLD; INFLATION DURING RETIREMENT 4%. RETURN OF INVESTMENTS 8% 10 Amount needed in retirement accounts to live at desired level Amount needed if we incorporate inflation during retirement years
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Forecast retirement information 1) what do I need to invest to get the amount Currently have $10,000 in my accounts; return will average 10%; Currently invest $500 per month 11 Monthly payment required to achieve goal
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Forecast retirement information 2) given my current program, what return do I need to achieve my goals? 12
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DISTRIBUTION FROM QUALIFIED PLANS REQUIRED DISTRIBUTIONS Minimum Distribution Rules All qualified plans are required to make minimum distributions when certain rules met Primary rule : age 70 ½ The RMD is determined by a formula Essentially divide the account balance by a life expectancy factor Failure to Make Distributions 50% penalty of the of the amount required and not paid If should have paid $10K and only paid $4K Penalty $3K 13
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DISTRIBUTION FROM QUALIFIED PLANS (Contd.) TAXATION OF KEOGH PLANS There is no lump sum distribution after retirement Withdrawals must begin by April 1 of the year after a person reaches 70-1/2 Ten-year forward averaging rule also applies to Keogh plans OTHER TAX CONSIDERATIONS Premature Distributions 10% penalty Certain exceptions Excess Contributions 10% penalty on the excess Insufficient Distributions 50% penalty on the shortage 14
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RETIREMENT INCOME: THE ULTIMATE DECISION Three principal ways to get your money Annuity The Annuity Principle A major concern is whether we will have enough money to last our lifetime Insurance companies can guarantee life income payments Disposition of Proceeds Variety of methods for payment (life income, period certain, etc) Tax Treatment of Annuity Payments Variable Annuity or fixed annuity The Best Choice? ? Lump Sum Distribution Forward Averaging Option IRA transfer and withdrawals 15
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16 Major Sources Of Retirement Income
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Forms of Annuities 17
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18 Disposition of Annuity Proceeds
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RETIREMENT INCOME: THE ULTIMATE DECISION (Contd.) LUMP SUM vs. IRA It is a taxing decision to choose between a lump sum distribution and an IRA transfer or rollover Best alternative depends on a host of tax-related factors Example: John & Betty Jones, both 65, set to retire at year-end John has the choice of $2,000 per month for life, or A lump sum of $250,000 IRA rollover with immediate withdrawals offers the best option If John lives to age 100, the annuity option is the best 19
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RETIREMENT INCOME: THE ULTIMATE DECISION (Contd.) IRA DISTRIBUTION An individual is free to choose any suitable distribution method, subject to restrictions linked to age 59-1/2 and 70-1/2 Two methods frequently used are: Systematic Withdrawal: Personal Investment Systematic Withdrawal: Insurance Plan 20
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21 RETIREMENT PLANNING STRATEGIES This section analyzes basic strategies used to accomplish variety of retirement planning objectives LOANS FROM QUALIFIED PLANS – Taking out loan from a qualified plan may be a better alternative than withdrawal, since no tax or penalty is imposed on a loan – However, ultimately taxes may be imposed. Also the plan may withdraw funds from your regular retirement account and place them in a safer investment like a money market as collateral.
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RETIREMENT PLANNING STRATEGIES (Contd.) PLANNING FOR RETIREMENT: ADDITIONAL CONSIDERATION Early Planning Needed Should strive to avoid penalty taxes and take advantage of beneficial tax treatments Minimum Distribution Rules Everyone’s RMD is calculated based upon Minimum Distribution Incidental Benefit (MDIB) life expectancy factor table One exception: when spouse is more than ten years younger and is sole beneficiary Chapter 14: Retirement Planning22
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RETIREMENT PLANNING STRATEGIES (Contd.) COMBO STRATEGY Basic Structure: Involves six steps: 1. Estimate client’s monthly budget 2. Determine client’s monthly Social Security income 3. Instruct client’s employer to transfer the lump sum directly from pension plan to an IRA with a money-market mutual fund 4. Calculate shortfall in budget 5. Set up a growth-oriented investment portfolio with desired degree of risk 6. Client should withdraw from this portfolio if and when funds are needed, subject to minimum compulsory distribution at age 70-1/2 Chapter 14: Retirement Planning23
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RETIREMENT PLANNING STRATEGIES (Contd.) COMBO STRATEGY (Contd.) Concluding Remarks: The Combo Strategy just described is merely one of many options available to a client. Chapter 14: Retirement Planning24
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