Retirement Benefits

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Retirement Benefits
MGMT 4030 - Managing Employee Reward Systems
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Purpose of Retirement Benefits

• Income Replacement at Retirement
• Maintain Standard of Living after Retirement
• Need About 80 Percent of Pre-Retirement Income
  from All Sources
• Retired Individuals get Special Tax Treatment,
  Have Less Expenses
• Employer Receives Special Tax Treatment by IRS
  When Benefits Are Qualified
• Use as asset to create wealth, borrow, or estate
  to leave to your heirs (children, relatives or
  charity)

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Sources of Retirement Income

• When you Decide to Retire...
• Retirement Benefits (50 Percent) - Most
  Significant Source
• pensions, employer sponsored savings plans
• Social Security (15 - 20 Percent)
• Personal Savings (25-30 Percent)
• home equity (most significant personal
  source),other investments

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Employee Income Security Act (ERISA) - 1974

• Protects Benefits from Mismanagement
• Eligibility for Benefits
• Employees Must Participate After One Year of
  Service or 1000 Hours in 12 Months
• Employee Vesting Schedules - Employer selects
• Vesting - right to take employers contribution
  to plan
• Cliff Vesting - 5 Years of Service (all or
  nothing)
• Partial Vesting - 7 Years of Service

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ERISA (Continued)

• Retirement Fund Administrators Obligated to Act
  with Prudence When Making Investments
• Only investments with reasonable risks are
  acceptable (such as blue chip stocks, not
  Internet stocks, commodities or options).
• Employers Required to Pay for Plan Termination
  Insurance - ensures availability of funds for
  retirees
• Pension Benefit Guaranty Corporation - Govt.
  Agency

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Defined Benefit Plans

• Benefit is Defined/Known in Advance
• Traditional Pension Plan - Large Firms Use It
• Benefit is Based on a Formula
• Average of Last 5 years of Salary
• Number of Years of Service
• Employer Assumes All Financial Risk

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Pension Fund Formula - DB Calculation

• Retirement (5 yr. ave. income) X (yrs. of
  service)
• (Percentage factor)
• Example 5 year ave. income 50K
• Years of service 30 years
• Percentage factor 1.5
• Retirement Income (50K)X(30)X(1.5)
• Retirement Income 22,500/year
• which is 45 of pre-retirement income

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Defined Contribution Plans

• Employer Contributions to Plan Are Known
• Benefits at Retirement are Unknown
• Depends on Success of Plans Investments
• Employee Shares Risk With Employer
• Takes Active Role in Managing Investments
• Examples 401(k) Plan, IRA, SEP, profit sharing
  plan

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401(k) Plans

• Fastest Growing Retirement Plan
• Employee Contributions and Retirement Earnings
  not Taxed
• Limit 15 of Salary up to 10,000/year
• Employee in for-Profit Business
• Employer Matches 25 to 100 percent of Employee
  Contributions
• May make self loans up to 50K

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401(k) Plan Tips

• Start your 401(k) immediately, take advantage of
  miracle of compound interest
• If 20 or more years from retirement, invest
  aggressively in stocks
• When changing jobs roll over money into new
  employers 401(k) if greater than 5K, if less
  than 5K roll into an IRA - there are large tax
  penalties for cashing out early (before age 59
  1/2).
• If paid in company stock, sell some of company
  stock when vested so there is diversification of
  assets and reduced exposure to risk.

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Mutual Fund Investments and 401(k) Plans

• Mutual Funds Definition A pooled investment
  with stated goals and with a professional
  manager.
• Advantages of Mutual Funds
• 1. Diversification - risk is pooled over many
  investments and accessible to middle class
  people.
• 2. Professional management - full time
  investment monitoring, with superior access to
  information.
• 3. Flexibility - possible to move money into
  diverse funds with different goals and levels of
  risk.

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Mutual Fund Investments and 401(k) Plans

• Types of Mutual Funds
• Low Risk
• Money Market funds
• Bond Funds
• Medium Risk
• Stock Funds (Growth and Value funds)
• Stock Index Funds (SP 500 Index, Dow Jones
  Index)
• High Risk
• International Funds
• Small Cap Funds (small and mid-sized firms)