Chapter 18

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CHAPTER 18

Personal Finance

Retirement Planning

Kapoor Dlabay Hughes

7e

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Misconceptions About Retirement Planning

My expenses will drop when I retire. My retirement will only last 15 years. I can depend on Social Security and my

company pension to pay for my basic living expenses.

My pension benefits will increase to keep pace with inflation.

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Misconceptions About Retirement Planning (continued)

My employers health insurance plan and Medicare will cover my medical expenses.

There’s plenty of time for me to start saving for retirement.

Saving just a little bit won’t help.

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The Importance of Starting Early To take advantage of the

time value of money. If from age 25 to 65 you invest

$300 a month (9%) at age 65 you’ll have 1.4 million in your retirement fund.

Wait ten years until age 35 to start and you’ll have about $550,000 at age 65.

Wait twenty years until age 45 and you’ll have only $201,000 at age 65.

See Exhibit 18-11.18-4

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Why Think AboutRetirement Planning Now?

People are spending more years (16-25) in retirement.

You don’t want to be bored, lonely and broke.

A private pension and Social Security are most often insufficient to cover the cost of living.

Inflation may diminish the purchasing power of your retirement savings.

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Review Your Assets for Retirement Housing.

If owned, probably your biggest single asset. If large equity, a reverse annuity mortgage

could provide additional retirement income. You could sell your home, buy a less

expensive one, and invest the difference.

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Review Your Assets for Retirement

Life insurance cash value can be converted into an annuity.

Review other investments, such as stocks and bonds.

(continued)

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Estimating Your Retirement Living Expenses Spending patterns and where and how you live will

probably change. Some expenses may go down or stop, such as 401(k)

retirement fund contributions. Work expenses - less for gas, lunches out. Clothing expenses - fewer and more casual. Housing expenses - house payment may stop if

your house is paid off by taxes and insurance going up.

Federal income taxes will probably be lower.

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Estimating Retirement Living Expenses Other expenses may go up.

Life and health insurance unless your employer continues to pay them.

Medical expenses increase with age. Expenses for leisure activities may go up. Gifts and contributions may increase.

Inflation will raise the amount you need to cover your expenses over the course of your probable 16-25 years in retirement.

(continued)

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How an “Average” Older (65+) Household Spends its Money

Food

Medical

Housing

Transportation ClothingContributions

Insurance and other

Entertainment

32.5%

11.3%

16.3%16.3%

15.4%15.4%

4.9%

5.7%

7.7%

6.2%

U.S. Bureau of Labor Statistics18-11

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Planning Your Retirement Housing Think about where you want to live. Consider the cost of living and taxes. Type of housing and changing needs.

Staying in their home that they own is what most people (92%) prefer.

A universal designed home is built to allow for potential physical limitations.

If not built using universal design, home may need to be retrofitted.

Continuing care retirement community provide increasing levels of care. 18-12

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Planning Your Retirement Income

Most widely used source of retirement income, covering 97% of U.S. workers.

Meant to be part of your retirement income, but not the sole source.

Check the Earnings & Benefit statement you receive each year for accuracy.

Full retirement benefits at age 65 to age 67, depending on the year you were born, but reduced benefits at age 62.

See www.ssa.gov.

Social SecuritySocial Security

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Future of Social Security The Social Security administration says the program is

financially sound, but many people are concerned about the future of Social Security.

Longer life expectancies means retirees collect benefits longer.

People are retiring earlier and entering the system sooner and staying longer.

The baby boomers will begin retiring soon and the ratio of workers to retirees is doing down. In 1945 there were 45 workers per retiree, In 2050 is it estimated there will be two workers per retiree.

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Individual accounts for each employee. Money-purchase pension plans - A percent of

your earnings are set aside, along with any employer contributions.

Stock bonus plans - Employer’s contribution is used to buy stock in your company for you.

Profit-sharing plans - Employer’s contribution depends on the company’s profits.

Planning Your Retirement Income

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Employer Pension Plans - Defined ContributionEmployer Pension Plans - Defined Contribution(continued)

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Planning Your Retirement Income

Salary reduction or 401(k), 403(b) or 457 plans.Employer makes non-taxable

contributions and reduces your salary by the same amount.

Employee contributions are tax-deferred.Some employers match a portion

of the funds you contribute.

Employer Pension Plans - Defined ContributionEmployer Pension Plans - Defined Contribution(continued)

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Planning Your Retirement Income

Employer will pay you a certain amount per month when you retire based on your pre-retirement salary and number of years of service.Employer makes the investment decisions for your and their contribution, but your benefit amount stays the same regardless of how the investments perform.

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Employer Pension Plans - Defined BenefitEmployer Pension Plans - Defined Benefit

(continued)

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Pension Plan Portability and Vesting Portability allows you to carry earned benefits from

one employer’s pension plan to another’s when you change jobs.

Vesting is your right to at least a portion of the benefits you have accrued under an employer pension plan, even if you leave before you retire.

When you leave a job you can cash in your pension (tax consequences), have the employer keep the funds so you will get a future pension from them, rollover the funds into an IRA, or transfer the funds to invest in a pension with your new employer if your pension is portable. 18-20

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Individual Retirement Accounts (IRA) The most popular personal retirement plan. Regular (traditional) IRA.

Lets you contribute up to $3,000 per year (see text chart as these amount are gradually rising).

Depending on your tax filing status and income, your contribution may be tax-deductible.

The interest accumulates tax free until you start taking it out.

You pay taxes on the money as you withdraw it once you are retired but must begin to withdraw funds by age 70 1/2. 18-21

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Individual Retirement Accounts Roth IRAs.

Contributions are not tax deductible, but earnings accumulate with distributions tax free after age 591/2.

You can contribute up to $3,000 ($3,500 if age 50 or older) per year if you are single and have an AGI of $95,000 or less or an AGI of $150,000 if you are filing jointly.

After five years, up to $10,000 can be used as a down payment on a first-time home buyer expenses penalty-free and tax-free. 18-22

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A Rollover IRA is a traditional IRA that accepts rollovers of all, or a portion, of your taxable distribution from a retirement plan or other IRA.

You decide where your money is invested. Many people put IRA money in a savings

account or CD rather than thinking about their options to invest for growth.

Stocks, company stock, bonds, and mutual funds are options for long term growth.

A Keogh is a pension plan developed for self-employed people, and their employees.

Individual Retirement Accounts

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The Education IRA (renamed Coverdell Education Savings Account)

You can give up to $2,000 a year to each child.

The accounts grow tax-free, and can be invested any way you choose.

The money can be used for elementary and secondary school costs, including books, tuition and tutoring.

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Annuities An annuity provides guaranteed income for life. If you have fully funded all other retirement plan

options, including your 401(k), 403b(7), Keogh, and profit-sharing plans but still want more money for retirement you may want to buy an annuity.

You can buy an annuity with the proceeds of an IRA or company pension, or as supplemental retirement income.

You can buy one with a single payment or with periodic payments.

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Annuities (continued)

You can also buy an annuity by converting the cash value of your life insurance policy into an annuity.

Interest accumulates tax free until payments begin. Immediate annuities are set up to begin payments

right away. With deferred annuities, income payments begin at

some future date. Contributions, and the interest they earn, are tax-deferred until you begin drawing the money out.

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Annuities (continued)

Options in annuities allow you to decide which is best for your situation. A straight-life annuity provides more income than

any other type, but payments stop when you die. The life-with-period-certain option guarantees the

number of payments. A joint-and -survivor annuity pays until the last

survivor you designate dies.

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Anticipated Sources ofRetirement Income

Social Security Administration, 1997

Social Security

Company pension

Part-time work

Spouse's pension

Savings12%12%

27%27%

Other9%9%

401(k) 7%7%

7%7%

18%18%

IRA

8%8% Home equity5%5%

7%7%

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