Argument for planning early for retirement is compelling

Transcription

1 CHAPTER 13 Basic Structure of Retirement Income 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 Planning for retirement involves four steps: Estimate pre-retirement expenses Determine desired standard of living based on (1) monthly/annual retirement expenses needed Estimate total expected income during retirement from all sources, including governmentsponsored plans, corporate & personal retirement plans, personal savings, and employment 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 Investment Employment During Retirement

2 PLANNING FOR RETIREMENT RETIREMENT PLANS: SOCIAL SECURITY

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4 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 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

5 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. Terms HCE = highly compensated NHCE non-highly compensated SPECIFIC REQUIREMENTS PARTICIPATION REQUIREMENTS 21 years old and 1 years employment must be covered If have immediate vesting 2 years employment may be required

6 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 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 plan Rules set to determine how much and when company is required to place funds in the PLAN INVESTMENT RULES Federal guidelines indicate that investments should be sufficiently : Liquid; Diversified; and conservative w/o undue risk Major Categories of Qualified Plans: Defined Contribution Plans Employee contribution usually a percentage Limits for different plans

7 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 Money Purchase Pension Plan Employer contribution Percentage or flat amount Maximum contribution 100% of income or50,000 (2012) Plans gains and losses allocated to participants Forfeitures may be reallocated Investments determined by trustee of the plan Simple Retirement Plan 100 or fewer employees Looks like a 401k plan (max 12,000) (2013) No discrimination rules problems if Employer matches up to 3 percent Or makes non-matching 2 percent contributions Simplified Employee Pension (SEP) Plan Employers make contributions into IRA

8 Very little paperwork Contribution must be made according to the formula maximum 51,000 or 25% if lower IRA rules followed except for the contribution limits Can still have individual IRA outside the work plan 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 401(k) Plan Company and employee contributions 17,500 employee contribution (5,500 catch-up 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 Stock Bonus Plan Profit sharing except employer s contribution can be stock or cash Thrift plan Hybrid of profit sharing and stock bonus plan

9 ESOP Invests primarily in company stock 15 KEY QUESTIONS 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 service

10 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 Age-Weighted Profit Sharing Plan must meet all the requirements of a regular profit sharing plan: 1. Maximum deduction is 25% (2007)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 (2012) 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

11 PERSONAL RETIREMENT PLANS INDIVIDUAL 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 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

12 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.