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CHAPTER 13Basic Structure of Retirement IncomeINTRODUCTIONArgument for planning early for retirement is compellingNationwide 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 retirementPlanning 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 government-sponsored plans, corporate & personal retirement plans, personal savings, and employment Take appropriate steps now if expected income falls short of expected expenditure needsKey sources of retirement income:Government Sponsored PlansCorporate Retirement PlansPersonal Retirement PlansPersonal InvestmentEmployment During RetirementPLANNING FOR RETIREMENT5943601403350015240036068000RETIREMENT PLANS: SOCIAL SECURITY100012500017430754572000Types of BenefitsRetirementNormal retirement age 67 if born after 1960If work longer benefits raisedMinimum retirement age is 62Lowers benefits (permanent)Benefits extend to spouse and children (max 50%)Survivors BenefitsChildren and spouse amount based on creditsDisabilityBased on inability to work (long-term)Has an impairment that will last at least 12 months or result in deathCould last for a lifetimePrivate usually only lasts until retirement ageMedicare (Health insurance program)Part A - hospital and nursing carePart B – medical insurance (premium)Part C – Medicare advantage (choose heath plans)Part D – Drug planCORPORATE RETIREMENT PLANSGENERAL DISCUSSIONThese 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.TermsHCE = highly compensatedNHCE non-highly compensated37578115031200SPECIFIC REQUIREMENTSPARTICIPATION REQUIREMENTS21 years old and 1 years employment must be coveredIf have immediate vesting 2 years employment may be requiredCOVERAGE REQUIREMENTSRatio Percentage TestCover a percentage of NHCE is at least 70% of the HCE coveredAverage Benefits TestMust benefit NHCE as a percentage of compensation compared to the HCEMinimum Participation TestOnly for defined benefit plansOutlines how many people must participateVESTING REQUIREMENTSHow long must you work until company contributions belong to the employeeFull vesting at end of 5 or graduated (20% per year)Immediate vesting can also be providedFUNDING REQUIREMENTSRules set to determine how much and when company is required to place funds in the planPLAN INVESTMENT RULESFederal guidelines indicate that investments should be sufficiently :Liquid; Diversified; and conservative w/o undue riskMajor Categories of Qualified Plans:Defined Contribution PlansEmployee contribution usually a percentageLimits for different plansEmployer contribution also a percentage of compensationRules applied if an employee terminates before vestedDefined Benefit PlansAmount contributed based on forecasts of future benefits to be paid out, current balances, and investment returnsTarget Benefit Plans: a hybrid of a money purchase (form of defined contribution) and defined benefit plansMoney Purchase Pension PlanEmployer contributionPercentage or flat amountMaximum contribution 100% of income or50,000 (2012)Plans gains and losses allocated to participantsForfeitures may be reallocatedInvestments determined by trustee of the planSimple Retirement Plan100 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 contributionsSimplified Employee Pension (SEP) PlanEmployers make contributions into IRAVery little paperworkContribution must be made according to the formula maximum 51,000 or 25% if lowerIRA rules followed except for the contribution limitsCan still have individual IRA outside the work planProfit Sharing PlanFormula determines contributionCan still make contributions if no profitLimited to 25% of compensation to ALL eligible employeesVesting rules applyIf employee leaves before vesting; the company’s contribution to the leaving employee’s plan can be1) used to reduce future contributions2) split between the remaining employees401(k) PlanCompany and employee contributions17,500 employee contribution (5,500 catch-up if over 50)Company can match but total combined contribution cannot exceed 45,000Individual 401k plans are available for self-employed without employees403B plans are very similar except a non-profit companyStock Bonus PlanProfit sharing except employer’s contribution can be stock or cashThrift planHybrid of profit sharing and stock bonus planESOPInvests primarily in company stock15 KEY QUESTIONS4292604000500Defined Benefit PlansA qualified employee pension plan that guarantees specified benefit level at retirementReward long-term employees with larger retirement benefitsFirst establishes the benefit employer wants employee to receive upon retirement, then contributions are set at the level necessary to achieve targeted benefitsFormula consists of either a flat dollar amount or a flat percentage of earningsDefined Benefit Plans include:Fixed benefit plans in which all employees receive the same benefitsFlat benefit plans where benefit is % of salaryUnit benefit plans in which benefit depends on income (optional) and time of serviceAge-Weighted Profit Sharing PlansOffer some of the best features of profit sharing and defined benefits plansAre cheaper than traditional defined benefit plansAre subject to less rigorous IRS regulatory requirements than those for defined benefit plansAge-Weighted Profit Sharing Plan must meet all the requirements of a regular profit sharing plan:1.Maximum deduction is 25% (2007)of covered payroll2.Each year employer maintains discretion over making contributions to the plan3.Maximum individual allocation for any one participant is $50,000 (2012) or 100% of salary, whichever is heavy plans must satisfy the 3% top-heavy minimum requirement for all non-key employees5.Forfeitures from non-vested accounts are allowed to be reallocated, or they may be used to reduce future contributions6.Investment earnings are allocated to participant accountsAge-Weighted Profit Sharing Plans 440055381000PERSONAL RETIREMENT PLANSINDIVIDUAL RETIREMENT ACCOUNT (IRA)Deductible versus Nondeductible ContributionsBefore tax Get tax deferral of earningsInvestment principal can be taken after certain rules metAfter-tax contributionsTax deferralAll withdrawals taxedContributions5,500 (indexed to inflation), or gross income1,000 catch up if over 50Types of IRAsTraditional IRATaxable withdrawalsTax deductibleRoth IRAWithdrawals not taxedAfter-tax contributionRollover versus TransferConverting an account such as a 401k from a previous employerTechnically rollover goes through investorTransfers are the prudent method of moving the assetsDEDUCTIBILITY OF IRA51323619470200IRA: Before versus After-Tax Contribution5130802466900This 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. ................
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