Retirement Planning

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Retirement Planning
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Worklife Retirement Life Expectancies
Retirement Life Expectancy
Worklife Expectancy
Current Age
Retire 62-65
Death 85 -
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Wage Replacement Ratio

• WRR ? estimate of percent of annual income needed
  in retirement compared to income just prior to
  retirement
• Ex Last year income 100,000
• First year retirement needs 80,000
• WRR 80,000/100,000 .80

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Ways to Estimate WRR

• Top-Down Approach ? begins with total income and
  deducts savings and payroll taxes useful for
  younger clients
• EX Suppose a client is saving 10 of salary just
  prior to retirement
• 100 - 7.65 FICA 10 saving 82.35 WRR

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Ways to Estimate WRR

• Budgeting approach ? attempts to estimate
  specific monthly expenses
• More appropriate for clients near retirement
  where actual expenses can be more easily
  estimated
• Ex see page 659 of text

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Changes in Income Needs

• Decreases
• Social Security taxes
• Savings
• Home mortgage (maybe)
• Work-related expenses
• Auto insurance (maybe)
• Other lifestyle changes

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Changes in Income Needs

• Increases
• Health care costs
• Increased travel
• Second home?
• Clubs activities (leisure)
• Expenditures on family/gifts/grandchildren

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Sources of Retirement Income

• Savings 42
• Social Security 40
• Pensions 18

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Retirement Risks

• Shortened work-life expectancy
• Lengthened retirement life expectancy
• Greater than expected inflation
• Lower than expected investment returns
• Overestimation of retirement benefits

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Basic Retirement Plans

• Qualified Plans
• Other tax-advantaged plans
• Non-qualified plans

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Qualified Plans

• Pension plans
• Profit-sharing plans

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Characteristics of Qualified Retirement Plans

• Employer contributions are not subject to federal
  income tax or payroll tax
• Employee contributions are not subject to federal
  income tax
• Employee contributions are subject to payroll tax
• Tax-deferred growth
• Special income tax averaging
• Net unrealized appreciation
• ERISA protection
• Timing of income tax deduction

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Tax Deferral Effect

• Non- Tax Advantaged
• Deposit 1,000
• Less Payroll tax 76.50
• Less Income tax (28) 280.00
• Net investment 643.50
• Earnings 12 x (1 28)
• Future value in 40 years 17,707

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Tax Deferral Effect

• Tax Advantaged
• Deposit 1,000
• Net investment 1,000
• Earnings 12
• Future value in 40 years 93,051
• Net of Tax 93,051 x (1 28) 66,997

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Disadvantages of Qualified Retirement Plans

• Costs to qualify, fund, and administer the plan
• Small business tax credit
• Annual compensation limit
• Eligibility requirements
• Coverage of employees
• Vesting requirements
• Top-heavy plans
• Disclosure requirements
• Annual testing
• Retirement plans as part of a compensation package

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Benefits of Tax Deferral

• Tax deferral is perhaps the biggest benefit for
  an employee who participates in a qualified
  retirement plan.
• Neither plan contributions nor earnings on
  contributions are currently subject to income
  tax.
• In retirement, when distributions begin, the plan
  participant will be in a lower income tax bracket
  than during the working years.

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Types of Qualified Retirement Plans

• Classified as
• Pension or Profit-sharing
• Defined-benefit or Defined-contribution
• Contributory or Noncontributory
• Corporate or Keogh

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Pension Plan vs. Profit-Sharing Plan

• A pension plan is a qualified plan structured to
  provide a regularly paid fixed sum at retirement
• A profit-sharing plan is a qualified
  defined-contribution plan featuring a flexible
  (discretionary) employer-contribution provision

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Defined-Benefit Plan vs. Defined-Contribution Plan

• A defined-benefit plan specifies the actuarially
  determined benefit that each employee receives at
  retirement.
• A defined-contribution plan specifies the annual
  employer current contribution. The amount of
  benefit received by an employee depends on what
  the account balance is at retirement.

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Pension Plan

• Mandatory funding (regardless of income)
• No in-service withdrawals
• No more than 10 in employer securities
• Up to 25, and sometimes more, of compensation

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Profit Sharing

• Flexible contributions by employer
• Up to 25 of covered employee compensation
• No restrictions on employer securities which can
  be purchased in plan may invest 100 in
  employer securities
• Ex Stock bonus and ESOP

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Contributory Plan vs. Noncontributory Plan

• Qualified retirement plans may be distinguished
  as either contributory (employee makes some
  contribution) or noncontributory (employer pays
  all).
• Most pension and profit-sharing plans are
  noncontributory.
• Exceptions are the 401(k) and thrift plan (an
  after-tax savings plan).

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401K Plan

• Employee can save up to 11,000, pre-tax
• Increases to 15,000 in 2006 indexed in 500
  increments after that
• Generally involves some employer matching
• EX Employee may give up to 6 and employer
  matches .50 on dollar up to 3

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Corporate Plan vs. Keogh Plan

• Corporate-sponsored plans
• Regular C corporations or S corporations
• Keogh plans (a qualified plan for unincorporated
  businesses)
• Self-employed, Schedule C, partnerships, LLCs
  filing as partnerships
• Contribution limit Plan /(1Plan )
• Ex 25 ? 25/1.25 20

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Other Tax-Advantaged Plans

• Individual Retirement Account (IRA) or IRA
  Annuity
• Traditional
• Roth
• Simplified Employee Plan (SEP)
• Savings Incentive Match Plan for Employees
  (SIMPLE)
• 403(b) Plan (analogous to 401K for non-profit)

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Simplified Employee Plan (SEP)

• Non-contributory plan
• Similar to profit-sharing, with less filing
  requirements
• Establishes individual retirement accounts for
  each employee
• Discretionary contributions up to 15 of
  compensation, up to 170,000 (25,000) Increased
  to 200,000

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SIMPLE Plans

• Minimal filing requirements
• Establishes IRAs employees make elective
  contributions, up to 7,000 in 2002
• No percentage limit
• Requires employer match
• Dollar for dollar, up to 3
• 2 contribution, regardless of employee

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Distributions from Qualified and Other
Tax-Advantaged Plans

• If the contributions were pre-tax, then both
  contributions and earnings are treated as
  ordinary income equal to the distribution, and
  thus receive ordinary income tax treatment.
• If the contributions were after-tax, the
  contributions are treated as a return of capital
  and the earnings are treated as ordinary income.
  Each distribution is prorated as to return of
  taxable basis and ordinary income subject to
  income tax.

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Nonqualified Plan

• A retirement plan that can discriminate in favor
  of executives, but which is not eligible for the
  special tax benefits available for qualified or
  other tax-advantaged retirement plans.
• Deferred-compensation plans
• Split-dollar life insurance
• Employee stock option plans (ESOP)

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Plan Choices

• Goal
• Simple w/flexible contributions
• Employee tax deferral
• Reduce Turnover
• Minimum employer contributions
• Guarantee employee pension

• Plan
• SEP
• 401k, 403b
• Graduated vesting
• 401k, 403b
• Defined benefit plan