chapter 13 basic structure of retirement income chapter 13: retirement income1

CHAPTER 13

Basic Structureof Retirement

Income

Chapter 13: Retirement Income 1

INTRODUCTION

Argument for planning early for retirement is compelling

Nationwide Financials Survey (2011): Americans are becoming increasingly concerned about retirement as the economic downturn stymied income growth and wreaked havoc on investments.

Wells Fargo Retirement Survey (2010): 72 percent of middle-class Americans between the ages of 25 and 69 expect to work through their retirement.

Gallop Poll (2011): The poll reveals that 66 percent of Americans ranked not having enough money for retirement as their top financial concern.

Wells Fargo-Harris Survey (2010): Survey reveals a disturbing gap between savings needs and savings rates.

This gloomy picture dims further by recognizing that pensions and Social Security might not provide sufficient cushion for retirement


INTRODUCTION (Contd.) Planning for retirement involves four steps:

(1) Estimate pre-retirement expenses (2) Determine desired standard of living based on (1)

monthly/annual retirement expenses needed (3) Estimate total expected income during retirement from all

sources, including government-sponsored plans, corporate & personal retirement plans, personal savings, and employment

(4) Take appropriate steps now if expected income falls short of expected expenditure needs

Key sources of retirement income: Government Sponsored Plans Corporate Retirement Plans Personal Retirement Plans Personal Taxable Investments Employment During Retirement


PLANNING FOR RETIREMENT

Figure 13-1 Planning for Retirement


RETIREMENT PLANS: SOCIAL SECURITY


SOCIAL SECURITY: FULL RETIREMENT AGE


Taxation of Social Security Benefits


Types of Benefits

Retirement Normal retirement age 67 if born after 1960

If work longer benefits raised

Minimum retirement age is 62

Lowers benefits (permanent)

Benefits extend to spouse and children (max 50%)

Survivors Benefits Children and spouse amount based on credits


Types of Benefits Disability

Based on inability to work (long-term)

Has an impairment that will last at least 12 months or result in death

Could last for a lifetime

Private usually only lasts until retirement age

Medicare (Health insurance program)

Part A - hospital and nursing care

Part B – medical insurance (premium)

Part C – Medicare advantage (choose heath plans)

Part D – Drug plan


CORPORATE RETIREMENT PLANS

GENERAL DISCUSSION These plans, known as qualified plans,

provide excellent means of accumulating wealth on a tax-deferred basis.

Corporate retirement plans offer tax advantages both to employer and employee.

HCE – highly compensated employees NHCE – non-highly compensated employees


Major Categories of Corporate Retirement Plans

Figure 13-3 Major Categories of Corporate Retirement Plans


CORPORATE RETIREMENT PLANS SPECIFIC REQUIREMENTS

PARTICIPATION REQUIREMENTS 21 years old and 1 years employment must be covered If have immediate vesting 2 years employment may be required

COVERAGE REQUIREMENTS Ratio Percentage Test

Cover a percentage of NHCE is at least 70% of the HCE covered

Average Benefits Test

Must benefit NHCE as a percentage of compensation compared to the HCE

Minimum Participation Test Only for defined benefit plans Outlines how many people must participate


CORPORATE RETIREMENT PLANS (Contd.)

VESTING REQUIREMENTS How long must you work until company contributions belong to

the employee Full vesting at end of 5 or graduated (20% per year) Immediate vesting can also be provided

FUNDING REQUIREMENTS Rules set to determine how much and when company is

required to place funds in the plan

PLAN INVESTMENT RULES

Federal guidelines indicate that investments

should be sufficiently : Liquid; Diversified; and conservative w/o undue

riskChapter 13: Retirement Income 13

TYPES OF CORPORATE RETIREMENT PLANS

Major Categories of Qualified Plans:

Defined Contribution Plans Employee contribution usually a percentage

Limits for different plans Employer contribution also a percentage of compensation Rules applied if an employee terminates before vested

Defined Benefit Plans Amount contributed based on forecasts of future benefits

to be paid out, current balances, and investment returns Target Benefit Plans: a hybrid of a money

purchase (form of defined contribution) and defined benefit plans


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Money Purchase Pension Plan

Employer contribution Percentage or flat amount

Maximum contribution 100% of income or 50,000 (2012)

Plans gains and losses allocated to participants

Forfeitures may be reallocated

Investments determined by trustee of the plan


TYPES OF CORPORATE RETIREMENT PLANS (Contd.)Simple Retirement Plan

100 or fewer employeesLooks like a 401k plan (max

12,000) (2013)No discrimination rules

problems ifEmployer matches up to 3

percentOr makes non-matching 2

percent contributions


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Simplified Employee Pension (SEP) Plan

Employers make contributions into IRA Very little paperwork Contribution must be made according to the

formula maximum 51,000 or 25% of income (if lower)

IRA rules followed except for the contribution limits

Can still have individual IRA outside the work plan


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Profit Sharing Plan

Formula determines contribution Can still make contributions if no profit

Limited to 25% of compensation to ALL eligible employees

Vesting rules apply If employee leaves before vesting; the

company’s contribution to the leaving employee’s plan can be

1) used to reduce future contributions

2) split between the remaining employees


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) 401(k) Plan

Company and employee contributions 17,500 employee contribution (5,500 if over 50)

Company can match but total combined contribution cannot exceed 45,000

Individual 401k plans are available for self-employed without employees

403B plans are very similar except a non-profit company Open to charitable institutions (501c)

Limited same as 401k

Much like a 401k


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Stock Bonus Plan

Profit sharing except employer’s contribution can be stock or cash

Thrift plan Hybrid of profit sharing and stock bonus

plan

ESOP Invests primarily in company stock


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Defined Benefit Plans

A qualified employee pension plan that guarantees specified benefit level at retirement

Reward long-term employees with larger retirement benefits First establishes the benefit employer wants employee to

receive upon retirement, then contributions are set at the level necessary to achieve targeted benefits

Formula consists of either a flat dollar amount or a flat percentage of earnings

Defined Benefit Plans include: Fixed benefit plans in which all employees receive the same

benefits Flat benefit plans where benefit is % of salary Unit benefit plans in which benefit depends on income (optional)

and time of serviceChapter 13: Retirement Income 21

TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Age-Weighted Profit Sharing Plans

Offer some of the best features of profit sharing and defined benefits plans

Are cheaper than traditional defined benefit plans

Are subject to less rigorous IRS regulatory requirements than those for defined benefit plans


TYPES OF CORPORATE RETIREMENT PLANS (Contd.) Age-Weighted Profit Sharing Plan must meet all the

requirements of a regular profit sharing plan:

1. Maximum deduction is 25% (2013) of covered payroll

2. Each year employer maintains discretion over making contributions to the plan

3. Maximum individual allocation for any one participant is $50,000 (2013) or 100% of salary, whichever is less

4. Top heavy plans must satisfy the 3% top-heavy minimum requirement for all non-key employees

5. Forfeitures from non-vested accounts are allowed to be reallocated, or they may be used to reduce future contributions

6. Investment earnings are allocated to participant accounts


Age-Weighted Profit Sharing Plans (Contd.)


Choice of Handling Lump-Sum Distribution


PERSONAL RETIREMENT PLANSINDIVIDUAL RETIREMENT ACCOUNT (IRA) An Overview:

Deductibility Provisions Summarized in Table 13-8 Regular IRA vs. Roth IRA Raised Contribution Limits

Long-Term Accumulation Deductible versus Nondeductible Contributions Types of IRAs

Individual Retirement Plan Individual Retirement Annuity Plan

Rollover versus TransferChapter 13: Retirement Income 26

PERSONAL RETIREMENT PLANSINDIVIDUAL RETIREMENT ACCOUNT (IRA) Deductible versus Nondeductible Contributions

Before tax Get tax deferral of earnings Investment principal can be taken after certain rules met

After-tax contributions Tax deferral All withdrawals taxed

Contributions 5,500 (indexed to inflation), or gross income 1,000 catch up if over 50


PERSONAL RETIREMENT PLANSINDIVIDUAL RETIREMENT ACCOUNT (IRA) Types of IRAs

Traditional IRA Taxable withdrawals Tax deductible

Roth IRA Withdrawals not taxed After-tax contribution

Rollover versus Transfer Converting an account such as a 401k from a previous

employer Technically rollover goes through investor Transfers are the prudent method of moving the assets


DEDUCTIBILITY OF IRA


IRA: Before versus After-Tax Contribution


This represents the taxes paid in the beginning. An opportunity cost. However, the actual dollars invested would be the same. The end balances would be the same.

chapter 13 basic structure of retirement income chapter 13: retirement income1

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raisedminimum retirement

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