Chapter 18


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Chapter 18

  1. 1. C HAPTER 18 18-1 Personal Finance Retirement Planning Kapoor Dlabay Hughes 7e
  2. 2. Misconceptions About Retirement Planning <ul><li>My expenses will drop when I retire. </li></ul><ul><li>My retirement will only last 15 years. </li></ul><ul><li>I can depend on Social Security and my company pension to pay for my basic living expenses. </li></ul><ul><li>My pension benefits will increase to keep pace with inflation. </li></ul>18-2
  3. 3. Misconceptions About Retirement Planning (continued) <ul><li>My employers health insurance plan and Medicare will cover my medical expenses. </li></ul><ul><li>There’s plenty of time for me to start saving for retirement. </li></ul><ul><li>Saving just a little bit won’t help. </li></ul>18-3
  4. 4. The Importance of Starting Early <ul><li>To take advantage of the time value of money. </li></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>Wait ten years until age 35 to start and you’ll have about $550,000 at age 65. </li></ul></ul><ul><ul><li>Wait twenty years until age 45 and you’ll have only $201,000 at age 65. </li></ul></ul><ul><ul><li>See Exhibit 18-11. </li></ul></ul>18-4
  5. 5. Why Think About Retirement Planning Now? <ul><li>People are spending more years (16-25) in retirement. </li></ul><ul><li>You don’t want to be bored, lonely and broke. </li></ul><ul><li>A private pension and Social Security are most often insufficient to cover the cost of living. </li></ul><ul><li>Inflation may diminish the purchasing power of your retirement savings. </li></ul>18-5
  6. 6. Review Your Assets for Retirement <ul><li>Housing. </li></ul><ul><ul><li>If owned, probably your biggest single asset. </li></ul></ul><ul><ul><li>If large equity, a reverse annuity mortgage could provide additional retirement income. </li></ul></ul><ul><ul><li>You could sell your home, buy a less expensive one, and invest the difference. </li></ul></ul>18-6
  7. 7. Review Your Assets for Retirement <ul><li>Life insurance cash value can be converted into an annuity. </li></ul><ul><li>Review other investments, such as stocks and bonds. </li></ul>(continued) 18-7
  8. 8. Estimating Your Retirement Living Expenses <ul><li>Spending patterns and where and how you live will probably change. </li></ul><ul><li>Some expenses may go down or stop, such as 401(k) retirement fund contributions. </li></ul><ul><ul><li>Work expenses - less for gas, lunches out. </li></ul></ul><ul><ul><li>Clothing expenses - fewer and more casual. </li></ul></ul><ul><ul><li>Housing expenses - house payment may stop if your house is paid off by taxes and insurance going up. </li></ul></ul><ul><ul><li>Federal income taxes will probably be lower. </li></ul></ul>18-8
  9. 9. Estimating Retirement Living Expenses <ul><li>Other expenses may go up. </li></ul><ul><ul><li>Life and health insurance unless your employer continues to pay them. </li></ul></ul><ul><ul><li>Medical expenses increase with age. </li></ul></ul><ul><ul><li>Expenses for leisure activities may go up. </li></ul></ul><ul><ul><li>Gifts and contributions may increase. </li></ul></ul><ul><li>Inflation will raise the amount you need to cover your expenses over the course of your probable 16-25 years in retirement. </li></ul>(continued) 18-9
  10. 10. How an “Average” Older (65+) Household Spends its Money U.S. Bureau of Labor Statistics 18-11 Food Medical Housing Transportation Clothing Contributions Insurance and other Entertainment 32.5% 11.3% 16.3% 15.4% 4.9% 5.7% 7.7% 6.2%
  11. 11. Planning Your Retirement Housing <ul><li>Think about where you want to live. </li></ul><ul><li>Consider the cost of living and taxes. </li></ul><ul><li>Type of housing and changing needs. </li></ul><ul><ul><li>Staying in their home that they own is what most people (92%) prefer. </li></ul></ul><ul><ul><li>A universal designed home is built to allow for potential physical limitations. </li></ul></ul><ul><ul><li>If not built using universal design, home may need to be retrofitted. </li></ul></ul><ul><ul><li>Continuing care retirement community provide increasing levels of care. </li></ul></ul>18-12
  12. 12. Planning Your Retirement Income <ul><li>Most widely used source of retirement income, covering 97% of U.S. workers. </li></ul><ul><li>Meant to be part of your retirement income, but not the sole source. </li></ul><ul><li>Check the Earnings & Benefit statement you receive each year for accuracy. </li></ul><ul><li>Full retirement benefits at age 65 to age 67, depending on the year you were born, but reduced benefits at age 62. </li></ul><ul><li>See </li></ul>Social Security 18-14
  13. 13. Future of Social Security <ul><li>The Social Security administration says the program is financially sound, but many people are concerned about the future of Social Security. </li></ul><ul><li>Longer life expectancies means retirees collect benefits longer. </li></ul><ul><li>People are retiring earlier and entering the system sooner and staying longer. </li></ul><ul><li>The baby boomers will begin retiring soon and the ratio of workers to retirees is doing down. </li></ul><ul><ul><li>In 1945 there were 45 workers per retiree, </li></ul></ul><ul><ul><li>In 2050 is it estimated there will be two workers per retiree. </li></ul></ul>18-16
  14. 14. <ul><li>Individual accounts for each employee. </li></ul><ul><ul><li>Money-purchase pension plans - A percent of your earnings are set aside, along with any employer contributions. </li></ul></ul><ul><ul><li>Stock bonus plans - Employer’s contribution is used to buy stock in your company for you. </li></ul></ul><ul><ul><li>Profit-sharing plans - Employer’s contribution depends on the company’s profits. </li></ul></ul>Planning Your Retirement Income 18-17 Employer Pension Plans - Defined Contribution (continued)
  15. 15. Planning Your Retirement Income <ul><ul><li>Salary reduction or 401(k), 403(b) or 457 plans. </li></ul></ul><ul><ul><ul><li>Employer makes non-taxable contributions and reduces your salary by the same amount. </li></ul></ul></ul><ul><ul><ul><li>Employee contributions are tax-deferred. </li></ul></ul></ul><ul><ul><ul><li>Some employers match a portion of the funds you contribute. </li></ul></ul></ul>Employer Pension Plans - Defined Contribution (continued) 18-18
  16. 16. Planning Your Retirement Income <ul><li>Employer will pay you a certain amount per month when you retire based on your pre-retirement salary and number of years of service. </li></ul><ul><li>Employer makes the investment decisions for your and their contribution, but your benefit amount stays the same regardless of how the investments perform. </li></ul>18-19 Employer Pension Plans - Defined Benefit (continued)
  17. 17. Pension Plan Portability and Vesting <ul><li>Portability allows you to carry earned benefits from one employer’s pension plan to another’s when you change jobs. </li></ul><ul><li>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. </li></ul><ul><li>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. </li></ul>18-20
  18. 18. Individual Retirement Accounts (IRA) <ul><li>The most popular personal retirement plan. </li></ul><ul><li>Regular (traditional) IRA. </li></ul><ul><ul><li>Lets you contribute up to $3,000 per year (see text chart as these amount are gradually rising). </li></ul></ul><ul><ul><li>Depending on your tax filing status and income, your contribution may be tax-deductible. </li></ul></ul><ul><ul><li>The interest accumulates tax free until you start taking it out. </li></ul></ul><ul><ul><li>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. </li></ul></ul>18-21
  19. 19. Individual Retirement Accounts <ul><li>Roth IRAs. </li></ul><ul><ul><li>Contributions are not tax deductible, but earnings accumulate with distributions tax free after age 59 1/2 . </li></ul></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>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. </li></ul></ul>18-22
  20. 20. <ul><li>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. </li></ul><ul><li>You decide where your money is invested. </li></ul><ul><li>Many people put IRA money in a savings account or CD rather than thinking about their options to invest for growth. </li></ul><ul><li>Stocks, company stock, bonds, and mutual funds are options for long term growth. </li></ul><ul><li>A Keogh is a pension plan developed for self-employed people, and their employees. </li></ul>Individual Retirement Accounts 18-23
  21. 21. The Education IRA (renamed Coverdell Education Savings Account) <ul><li>You can give up to $2,000 a year to each child. </li></ul><ul><li>The accounts grow tax-free, and can be invested any way you choose. </li></ul><ul><li>The money can be used for elementary and secondary school costs, including books, tuition and tutoring. </li></ul>18-24
  22. 22. Annuities <ul><li>An annuity provides guaranteed income for life. </li></ul><ul><li>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. </li></ul><ul><li>You can buy an annuity with the proceeds of an IRA or company pension, or as supplemental retirement income. </li></ul><ul><li>You can buy one with a single payment or with periodic payments. </li></ul>18-25
  23. 23. Annuities (continued) <ul><li>You can also buy an annuity by converting the cash value of your life insurance policy into an annuity. </li></ul><ul><li>Interest accumulates tax free until payments begin. </li></ul><ul><li>Immediate annuities are set up to begin payments right away. </li></ul><ul><li>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. </li></ul>18-26
  24. 24. Annuities (continued) <ul><li>Options in annuities allow you to decide which is best for your situation. </li></ul><ul><ul><li>A straight-life annuity provides more income than any other type, but payments stop when you die. </li></ul></ul><ul><ul><li>The life-with-period-certain option guarantees the number of payments. </li></ul></ul><ul><ul><li>A joint-and -survivor annuity pays until the last survivor you designate dies. </li></ul></ul>18-27
  25. 25. Anticipated Sources of Retirement Income Social Security Administration, 1997 Social Security Company pension Part-time work 18-28 Spouse's pension Savings 12% 27% Other 9% 401(k) 7% 7% 18% IRA 8% Home equity 5% 7%