1111 preparing for retirement: what you can do now to prepare august 17, 2012 bryan sudweeks, ph.d.,...

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Preparing for Retirement:

What You Can Do Now to Prepare

August 17, 2012

Bryan Sudweeks, Ph.D., CFA.

From the Marriott School of Management’s“Personal Finance: Another Perspective” web site at

http://personalfinance.byu.edu 1

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Abstract• A prophet counseled “Plan your financial future early;

then follow the plan.” Our goal today is to help with that counsel (and perhaps scare you a bit into action). We start first with principals of personal finance, myths of retirement planning, steps to retirement planning, stages of retirement planning, asset allocation for retirement, and then selecting investment vehicles for saving and retirement. The key is to learn the lessons from our retirement planning challenges that the Lord wants us to learn and then to take the steps necessary to get going. God will help us prepare for retirement if we do it in His way and with His help.

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Objectives

• A. Understand the principles of personal finance

• B. Understand some myths of retirement planning

• C. Understand the steps and stages of retirement planning

• D. Understand asset allocation for retirement• E. Understand how to select investment

vehicles for retirement

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steps to retirement planning,

• President Ezra Taft Benson counseled:

• Plan for your financial future. As you move through life toward retirement and the decades which follow, we invite all . . . to plan frugally for the years following full-time employment. Be even more cautious . . .about “get-rich” schemes, mortgaging homes, or investing in uncertain ventures. Proceed cautiously so that the planning of a lifetime is not disrupted by one or a series of poor financial decisions. Plan your financial future early; then follow the plan. (italics added, “To the Elderly in the Church,” Ensign, Nov. 1989, 4).

A. Key Principles of Personal Finance

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• 1. Financial management (personal finance) is not separate from the gospel of Jesus Christ, it is the gospel of Jesus Christ• It encompasses three of the four-fold missions of

the church:

• To perfect the saints

• To preach the gospel

• To take care of the poor and needy

Principles of Personal Finance (continued)

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• 2. Financial management is just as much a part of the gospel as is family history, food storage, employment, welfare, and other areas• The responsibility is for us to be wise stewards:

• For it is expedient that I, the Lord, should make every man accountable, as a steward over earthly blessings, which I have made and prepared for my creatures (D&C 104: 13).

• And verily in this thing ye have done wisely, for it is required of the Lord, at the hand of every steward, to render an account of his stewardship, both in time and in eternity (D&C 72:3).

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• 3. We must feast upon the words of Christ and live worthy of the Holy Ghost which shall tell us and who show us all things we should do (regarding financial management)• And study and learn, and become acquainted with

all good books, and with languages, tongues, and people (D&C 90:15).

• Let him that is ignorant learn wisdom by humbling himself and calling upon the Lord his God (D&C 136:32).

• Feast upon the words of Christ, for behold, the words of Christ will tell you all things that you should do (2 Nephi 32:3).

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• 4. The only things that are truly ours are our minds and our will. Elder Neal Maxwell said:• The submission of one’s will is really the only

uniquely personal thing we have to place on God’s altar. The many other things we “give,” brothers and sisters, are actually the things He has already given or loaned to us. However, when you and I finally submit ourselves, by letting our individual wills be swallowed up in God’s will, then we are really giving something to Him! It is the only possession which is truly ours to give! (italics added, “Swallowed Up in the Will of the Father,” Ensign, Nov. 1995, 22.) 8

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B. Myths of Retirement Planning

• There are a number of myths that people believe in which are damaging to the process of preparing for retirement• We need to fight these myths

• In retirement planning, we must do what we can based on where we are today to prepare for the future ahead

• Any preparation we do now will help us in the future

• Likewise, any lack of preparation we fail to do today could impact our retirement later

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Myth 1. Retirement Planning is Easy

• Many say it is not hard to plan for retirement• We don’t have to do anything

• All we have to do is save a little money each year

• Retirement will take care of itself—don’t worry, be happy

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Reality 1. Retirement Planning Takes Sacrifice

• To retire at your current level of income will likely require a significant level of sacrifice• There is a tradeoff between what you spend now and

what you will spend in retirement• You will need to give up much of what you want

now, for something else, a better retirement in the future

• You need to live on a budget• You likely need to curtail spending• You likely need to save a significant portion of

your income

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Myth 2. I can Spend my Way to Retirement• Some think they can spend their way to a

successful retirement (who do you think you are, the government?)• They don’t have to save or budget

• They can continue buying nice cars, big houses, and spending on expensive things

• They don’t have to get out of debt—they can do that later, including pay off their houses after retirement

• And because they pay their tithing, everything else will work out, including a successful retirement

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Reality 2. You Must Save for Retirement

• The most important things you can do now to save for retirement is to do the things I have talked about all this week. They are:• 1. Get on a budget and start saving MORE

• I recommend 10-20% for young people or more if you are closer to retirement (20%+)

• 2. Get and stay out of debt

• Do not go into new debt

• Reduce your expenditures

• Pay off your house before you retire

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Reality 2. You Must Save (continued)

• 3. Decide if you will help with your children’s missions and education

• However, do not put your retirement at risk to help with your children’s education

• Do not borrow against your retirement assets or your home to help with children’s education expenses!

• 4. Get serious about retirement planning• Get the budget in place• Reduce both fixed and variable expenses• Save as much as you can• Develop a retirement plan

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Myth 3. Social Security is Enough

• Some think that they will be able to continue their current life style with only Social Security• They don’t have to get out of debt or prepare for

retirement because the government will do it all

• They feel it is the government’s responsibility, not theirs, to fund their retirement

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Reality 3. You are Responsible

• Social security was never intended to be the entire retirement program for working people• It was intended to cover about 43% of retirement

needs—not 100% as many people expect

• According to Social Security, the average fully insured worker, Wanda Worker, at full retirement age of 67 years, would receive $18,648 a year

• While this is an estimate, it will be hard to survive on $18,648 a year

• Social security was never meant to cover all the expenses of retirement

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Myth 4. Social Security is Secure

• Some expect that the benefits promised from social security are guaranteed and will always be there• Every dollar that was promised by the government

is secure and will be there

• After all, it is the government

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Reality 4. Social Security is a Promise• Social security is a promise

• However, financial realities are making tough choices (we are spending 40% more than taxes bring in)

• Entitlement spending is the fastest growing part of the governments budget

• The Social Security system was created for a different time and problem

• Starting in 2015, it will be paying more in benefits than it collects in taxes

• In 2037, the Social Security Trust Fund will only be able to pay out about 78 cents for each dollar of scheduled benefits

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Myth 5. My Kids will Take Care of Me• Some feel that they do not have to prepare for

retirement• Because they took care of their kids when they were young,

their kids will take care of them when they are older

• It is the kids responsibility to care for their parents, isn’t it (wasn’t that why we had 7 kids?)

• Isn’t that what it means when it says “honor thy father and thy mother”?

• Give them all the money they need for retirement—money they were not willing sacrifice and save for themselves when they were in their working years

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Reality 5. It’s Tough for Your Kids Too

• Your children are living in an environment that is equally challenging for them• It will be a challenge for them just to support

themselves and their families• Economic growth and investment returns will likely

be lower than in previous years• The financial environment will remain challenging

• They are responsible to support their own families and to prepare for their own retirement• You need to be responsible to prepare for yours as

well

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Myth 6. You Need $2 Million at Retirement

• Some think you need at least $2 million saved at retirement• Unless you have that $2 million saved at

retirement, you are going to have to continue to work and never retire

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Reality 6. It Depends. . .• Retirement needs are a function of:

• Your fixed expenses at retirement:• These are expenses that will not change in the short-

term for health, home, utilities, and debt. We need to reduce these expenses

• Your variable expenses at retirement• These expenses are changeable depending on our

wants and needs, for food, gas, phone, etc.• Other expenses at retirement

• These are optional expenses such as costs for visiting the grandkids, going on vacations, golfing and other retirement activities

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It Depends (continued)

• What are your goals in retirement?• Have you thought about them?

• Have you written them down?• Ideally you should develop a lifestyle before you retire

that you can continue during retirement• Have you determined what it would take to continue

this lifestyle every year?• Have you taken inflation into account? And earnings on

your savings? When will you retire?• “I tell you these things because of your prayers; . . .

but if ye are prepared, ye shall not fear (D&C 38:30).

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Myth 7. I Will Retire at Age 62

• Some consider that they will retire at age 62, regardless of their debt situation and how much money they have saved for retirement• That is the age the government says they can retire

(i.e. 5 years before full retirement age) and they are going to retire at that age regardless

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Reality 7. Are You Prepared to Retire?

• Yes, you can retire at age 62, five years before Social Securities’ full retirement age• However, you will receive 30% less each month for

the rest of your life from Social Security than you would have had you retired at full retirement age

• Using Wanda Worker as an example, instead of $18,648 a year, you would receive $13,054

• Can you live on $13,000 a year?

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C. Understand the Steps and Stages of Successful Retirement Planning

• Step 1. Know yourself• Understand your personal and family goals

• Know what you want out of life

• Write down your personal and family goals

• Understand what kind of retirement you want

• Determine the things you want to do in retirement

• Determine the type of retirement you want

• Be willing to work toward those goals

• Determine how much money you will need each year in retirement

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Steps and Stages (continued)

• Step 2. Understand the retirement investment vehicles available and how use them wisely• Understand and use tax-advantaged retirement

vehicles to your advantage:

• Employer Qualified Plans: 401(k), Roth 401(k), 403(b), Roth 403(b), or 457 retirement plans for the employee

• Individual and Small Business Plans: IRA’s (Roth and traditional), Keoghs, SEP’s and SIMPLE’s for the self-employed

• Government Plans: Social Security

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• Step 3. Choose wisely the financial assets for those vehicles and invest at a risk level you are comfortable with• Determine a risk level you are comfortable with and

invest accordingly

• Choose the financial assets which will earn the highest after-tax returns to reach your goals consistent with your tolerance for risk

• Follow the principles of successful investing

• Do not invest beyond your tolerance for risk, i.e., take on more risk, just because you are behind in your savings goals 28

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• Step 4. Determine how much you will need at retirement (AR)• 1. Estimate how much you need before-tax AR

• 2. Estimate your current annual income AR from social security and defined benefit plans

• 3. Determine how much you have accumulated so far AR on a before-tax basis

• 4. Estimate total retirement needs after inflation

• 5. Determine the contribution or reduction to your retirement plans from your home

• 6. Determine how much you will need to save each month and start today to save (see Learning Tool 6 on the website)

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• Step 5. Develop a good retirement plan, write it carefully, and follow it closely• The most important thing you can do to help you

prepare for retirement is to live on a budget and save a percentage of your income for retirement

• Set goals as to the percent of your income you will save each month for retirement (increase it!)

• Check yourself regularly to make sure you are on track with your savings goals

• Monitor performance, rebalance, and re-evaluate your retirement portfolio as needed consistent with your level of risk 30

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• Step 6. Start today!• Be diligent in following your budget and setting

aside money for retirement

• The longer you wait to start saving for retirement each month, the more money you will need each month for the same amount

• Invest wisely and in the most advantageous retirement investment vehicles

• Have your money earning money to help you reach your retirement goals

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• There are three stages to retirement planning:• Stage 1: Accumulation

• This stage begins when you start work and is the time where you accumulate assets which you will later use for retirement

• You need to develop a plan for this stage on how you will save money for retirement in the years before you retire

• You should get on a budget and save a percent of your income each month (10% minimum recommended)

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• Accumulation strategies could include:

• Develop and live on a budget and save 10% for retirement, always getting the company match first

• Save 20% of every dollar you earn, with 15% into the company 401k (or Roth 401k) before the match, 3% into the taxable account for retirement, and 2% into children’s mission and education funds

• Save 15% of every dollar, with 10% into the Roth IRA for both you and your spouse (before the match), 3% into education IRAs for the children, and 2% into mission accounts for the children

• Invest in Roth accounts while you are young and when your tax rates are low

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• Stage 2: Retirement or Annuitization• This stage begins when you retire

• It is your plan on how your assets will be distributed at retirement

• Your goal is to have sufficient assets for your lifetime to enable you and your spouse to live like you planned

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• Retirement strategies might include:• Calculate a minimum acceptable level of retirement

income, and annuitize that amount if you have sufficient assets. The process is to:

• a. Calculate your take home amounts from Social Security and any defined benefit plan(s)

• b. Determine the minimum amount needed to live comfortably, and

• c. Take a percentage of your investment assets at retirement (if sufficient) to purchase an immediate annuity to give you the minimum amount needed (b-a) each month to receive your minimum acceptable level of income

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• Stage 3: Distribution/disposition/decumulation• This stage begins after you have retired

• This is your plan as to how best take distributions from your remaining retirement and taxable accounts to minimize taxes and maximize the availability of your assets

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• Distribution strategies might include:• Set up a framework where you will not outlive your

assets. Recommendations include:

• Take out maximum distribution of 3.6% of total assets each year , or only take out maximum earnings from investments of previous year

• During your later years which your income is less, i.e., during missions, transfer money from your tax-deferred to tax-eliminated accounts

• Use this time to move assets into Roth accounts with as little tax consequences as possible

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D. Understand Asset Allocation for Retirement

• What is asset allocation?• It is the process of determining what percent of your

portfolio to put in each asset class

• Why is it important?• There is where you determine your risk level for your

assets• For conservative investors, you would have more

assets in less risky asset classes, i.e., government securities, bonds, cash

• For more risk investors, you would have more in stocks including large cap stocks, small cap stocks, international stocks, etc.

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Asset Allocation (continued)

• What is the process?• Asset allocation is a two step process

• 1. Assume your age in bonds

• If you were 65 years old, you would have 65% of your assets in bonds and cash

• 2. Adjust this based on a risk tolerance test

• If you were more conservative, you would have 75-85% in bonds

• See Learning Tool 16 from the website to give ideas on your risk tolerance

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E. Understand Selecting Investment vehicles for Investing and Retirement

• What is the process of selecting investment vehicles?• It is the process of understanding which types of

investment vehicles will help you achieve your goals the fastest

• Why should we learn it?• Investment vehicles have different benefits, i.e.,

due to matching (free money), tax avoidance, tax deferral, or tax-efficient and wise investing

• The wise use of correct investment vehicles will help you save more money to help you reach your financial goals faster

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Selecting Investment Vehicles (continued)

• What is the difference between investment vehicles and financial or investment assets?• The investment vehicle is the tax-law defined

framework that has specific tax advantages, i.e., 401k, 403b, Individual Retirement Account (IRA), SEP IRA, Roth IRA, Roth 401k, etc.

• It is like the shopping cart in the grocery store

• The financial assets are the securities that are invested in by the vehicles, i.e., stocks, bonds, mutual funds, REITs, MMMFs, CDs, etc.

• It is like the groceries you put in your shopping cart

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Select Investment Vehicles for 2012 (before catch-up)

Tax- Tax- MaximumPlan deferred eliminated Amount/Year For Employees of:401-k Y $17,000 Businesses w/plansRoth 401-k Y 17,000 Businesses w/plans403-b Y 17,000 Non-profit, tax-exemptRoth 403-b Y 17,000 Non-profit, tax-exempt 457 Y 17,000 State/municipalitiesSEP IRA Y 49,000 Small businessesSIMPLE IRA Y 11,500 Small businessesIRA Y 5,000 IndividualsRoth IRA Y 5,000 IndividualsEducation IRA Y 2,000 Individual Education529 Plans Y >390,000 p.c. Individual Education

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• What is the priority of money?

1. Free money• Matching money that is made available by your

company to encourage participation in company retirement plans, i.e., 401k, Roth 403b, Keogh, etc.

• Money made available through tax benefits, i.e. 529 plan contributions

What are the risks?

• You must stay at the company a certain number of years to become fully vested, i.e., to be able to take full ownership of these funds, or use the funds for education expenses for 529 plans 43

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2. Tax-advantaged money• a. Elimination of all future taxes

• This money can be used at retirement (or for education) without penalty and without taxes, i.e., a Roth IRA/410k/403b for retirement, and 529 Funds and Education IRA for education

• In addition, with the Roth, you can take the principle out without penalty at any time

What are the risks?

• You must be 59½ to receive earnings

• 529 Funds, Education IRA, and EE/I bonds must be for qualified expenses to be tax-free 44

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b. Tax-deferred money

• This money has the ability to be invested before-tax, with principle and earnings taxed only at retirement (IRA, SEP IRA, etc.)

What are the risks?

• You must be 59½ to take distributions. If you take the funds out before retirement, there is a 10% penalty and funds are taxed at your ordinary income tax rate for both federal and state

• This money converts long-term capital gains into short-term income for tax purposes

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3. Tax-efficient and wise investments• This is money that is invested tax-efficiently and

wisely, consistent with the investment principles discussed earlier

• What are the risks?

• Earnings are taxed consistent with the assets invested in

• You need to take into account the tax and transaction cost implications of whatever you invest in

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• How do you invest tax efficiently?• 1. Know the impact of taxes

• 2. Look to Capital Gains—defer earnings and taxes to the future

• 3. Minimize Turnover and Taxable Distributions

• 4. Replace interest income with stock dividends

• 5. Invest tax-free

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• How do you prioritize investment vehicle choice?• Some investment vehicles are higher on the

priority list than others, but they also have lower contribution amounts (i.e., $5,000 for the Roth in 2011). What should you do?

• Use the highest priority money first, and then next highest, etc. until you have utilized all your available investment funds

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• Where should you put different types of financial assets?• Retirement Accounts: 401k, IRA’s, 529 Funds, etc.

• Financial assets in which you trade actively• Taxable bonds, and high turnover funds

• You do not pay taxes until you take out funds

• Taxable Accounts: investment portfolios• Stocks and mutual funds with a buy and hold

strategy• Tax-free bonds and tax-efficient index funds

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Summary

• A. Understand four key thoughts on personal finance

1. Financial management is not separate from the gospel of Christ—it is the gospel

2. Financial management is just as much a part as family history, foot storage, etc.

3. We must feast on the words of Christ and live worthy of the Holy Ghost who will help us with our financial management

4. The only things that are truly ours are out minds and our wills

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Summary (continued)

• B. Understand the myths of retirement planning• 1. Retirement planning is easy

• 2. I can spend my way to retirement

• 3. Social Security is enough

• 4. Social Security is secure

• 5. My kids will take care of me

• 6. You need $2 million saved at retirement

• 7. I will retire at age 62

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Summary (continued)

• C. Know the steps and stages of successful retirement planning• 1. Know yourself

• 2. Understand the retirement vehicles available

• 3. Choose wisely the assets for those vehicles

• 4. Know the retirement planning steps

• 5. Develop a good retirement plan and follow it

• 6. Start today

• Stages of retirement

• Accumulation stage, retirement stage, and accumulation state

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Summary (continued)

• D. Understand asset allocation for retirement

• Invest at a risk level you are comfortable with

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Summary (continued)

• E. Understand how to select investment vehicles for saving and retirement• 1. Free money

• Matching money from your employer or from tax benefits

• 2. Tax advantaged money

• A. Tax eliminated money (i.e., Roth vehicles)

• B. Tax deferred money (traditional IRA/401k)

• 3. Tax efficient and wise investing

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1111 preparing for retirement: what you can do now to prepare august 17, 2012 bryan sudweeks, ph.d.,...

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