Planning For Retirement
Chapter 14
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Learning Goals
Recognize the importance of retirement planning, and identify
the three biggest pitfalls to good planning.
Estimate your income needs in retirement and the level of
retirement income you’ve estimated from various sources.
Explain the eligibility requirements and benefits of the Social
Security program.
Differentiate among the types of basic and supplemental
employer sponsored pension plans.
Describe the various types of self-directed retirement plans.
Choose the right type of annuity for your retirement plan.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
How Will This Affect Me?
While almost everyone understands that planning for retirement is important, far
too few people actually implement a comprehensive plan, much less set aside
enough savings to fund their retirement adequately. This chapter discusses the
importance of retirement planning and encourages action by identifying the major
pitfalls that you must overcome. In order to make the process more concrete and
accessible, the steps for estimating your retirement income needs and the income
that your investments will support are explained. Eligibility requirements to receive
Social Security benefits and their amounts are detailed, as well as the key aspects
of supplemental employer-sponsored pension plans and the potential benefits of
self-directed retirement programs like traditional and Roth individual retirement
accounts (IRAs). In addition, the usefulness of various annuity products in
retirement planning is evaluated. After reading this chapter, you should
understand how to develop and implement a financial plan that will help you
achieve your long-term retirement objectives.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Financial Facts or Fantasies?
 The first step in retirement planning is to set your retirement goals.
 In order to receive maximum social security retirement benefits, a worker
must retire before his or her 66th birthday.
 Social security retirement benefits should be sufficient to provide retired
workers and their spouses with a comfortable standard of living.
 Because participation in a company’s defined benefit pension plan is
mandatory, you’re entitled to immediate vesting of all contributions.
 Your contributions to an IRA account may or may not be tax deductible,
depending in part on your level of income.
 Since an annuity is only as good as the insurance company that stands
behind it, you should check the company’s financial rating before buying an
annuity.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Retirement Planning
Start Now!
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Retirement Planning
 First step is to set retirement goals
Standard of living when retired
What income level you will need to fund that standard
Relocation costs
 Determine the amount you need to accumulate for retirement
 Design an investment program to build you “nest egg”
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Pitfalls to Retirement Planning
 Starting too late – Many wait until they are in their 30’s or later
 Putting away too little – Tendency to spend now
 Investing too conservatively – Earlier you start, more risk you
can take; low-yielding investments will build small nest eggs.
 Compounding rewards the investor who starts early
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Power of Compounding
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Determining Future Retirement Needs
 Start with current living expenses
 Estimate future as a percent of current, rule of thumb 80%
 Estimate Retirement Income
 Social Security benefits
 Company retirement benefits/pension plan
 Investments
 See Worksheet 14.1
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Worksheet 14.1 Parts I & II
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Worksheet 14.1 Parts III & IV
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Determine Annual Savings
 Determine the total need investments for retirement
 To determine systematic saving amount needed
 Future amount divided by annuity factor from Appendix B
equals annual savings needed
 Example: Additional amount needed at retirement $334,950
 Annuity factor, assuming 6% per year over 30 years, from
Appendix B 79.078
 Annual saving need: $334,950 / 79.078 = $4,237
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Sources of Retirement Income
 Employer pension plan
 Social Security benefits
 Income from investments
 Employment, full or part-time
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Source of Retirement Income
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Social Security
 Qualifications: Must worked 40 quarters or 10 years of fulltime
work
 For Full benefits, must meet qualifying age requirement:
 If born in 1960 or later, full retirement age is 67
 Benefits are increased by 8% per year if defer taking benefits
after age 67 until you reach age 70. No addition increase
after age 70
 Surviving spouse and minor children receive benefits if worker
meets 40 quarters test or had 6 quarters during previous 3
years.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Social Security
 Primary funding provided by FICA tax which is 6.2% of salary
and wages up to a limit that is adjusted for inflation each year.
For 2015 the limit is $118,500. The employer matches the
amount paid by the employee, thus a total of 12.4% of salary
up to limit is paid each year. People who are self-employed
must pay the total 12.4% of self-employment income, again
up to the limit amount.
 The other part of FICA tax [1.45% by employee and employer]
is for Medicare.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Social Security Benefits
 if you retire at full retirement age in 2015, your maximum
benefit would be $2,663 per month. This amount would be
reduced by Part B Medicare premiums and income tax
withholding, if any. This amount assumes that you paid in the
maximum in each of your 40 quarters.
 Spousal benefits if worker retired would be half of the amount
received by worker.
 For middle income taxpayers, 85% of benefits are included in
taxable income.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Average Social Security Benefits
Type of Beneficary Average Monthly Benefit
Retired worker $1,328
Retired Couple $2,176
Disabled worker $1,165
Dixabled worker with spouse and child $1,976
Widow or widower $1,274
Young widow or widower with two
children
$2,680
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Pension Plans
 About 40 percent of full-time workers covered by employer
funded pension plans.
 Trend is increasing use of defined contribution plans funded
with salary reduction agreements by employee.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Pension Plans -- Basics
 Two types of pension plans
 Defined Benefits Plan – Benefits determined by formula such
as 2% or final salary for each year of service. Thus, if you
worked 30 years and your final salary was $50,000, your
pension would be $30,000 per year. Employer must add to
pension fund an amount each year that will provide the
estimated benefits for its employees. These funds are
invested and subject to market risk. Employer takes the risk;
not the employee.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Pension Plans -- Basics
 Defined Contribution Plan
 An amount is added to the plan each year [perhaps 10% of
salary] and is invested. The amount could be paid by the
employer, employee, or both.
 Benefit is based upon the amount in the plan at time of
retirement. Employee bears the market risk since pension will
vary based upon market return of the funds in the plan.
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Pension Plans -- Basics
 Cash balance plan
 Fully funded by employer who guarantees a minimum return
on the funds, e.g. 2% per year. The funds are invested for the
employee’s benefit. Pension is based upon the balance in
fund at retirement. Pension is not related to salary at
retirement.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Pension Plans -- Basics
 Participation in plan
 Must be non-discriminatory, that is cannot give greater
benefits to higher income employees than lower paid.
 Plan will vest, that is belongs to the employee, either
immediately when work is done, a cliff vesting no benefits for
first three years then 100% vesting, or graded scheduled
such as 20% vested at end of first two years, then 20% per
year so fully vested at end of six years.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Supplemental Plans
 Employer may provide opportunity for employee to contribute
to a supplemental plan
 Salary reduction agreements
 Funds contributed to the plan are invested and are tax
deferred until withdrawn by employee, typically at retirement
 How funds invested could be decided by employer or
employee.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Types of Supplemental Plans
 Profit-Sharing Plans –
 Funded by employer,
 Amount contributed depends upon profits of company, will
vary each year,
 May be invested entirely in stock of the company and subject
to risk of company failing
 May be invested in a portfolio of securities
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Types of Supplemental Plans
 Thrift and Savings Plans
 Employer matches some portion of contributions by employee
 Funds Invested by trustee for benefit of employees in a
portfolio of securities
 Employer’s contribution is tax deferred; Employee’s
contribution is included in taxable income [similar to a ROTH
account]
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Types of Supplemental Plans
 401(k), 403(b), or 457 plans
 Employer make contributions to plan using funds withheld
from employee under a salary reduction agreement
 Employee selects where to invest funds, typically from a list of
approved by employer plans, and typically invested in mutual
funds
 Amount is limited and limit changes with changes in the CPI
 Limit for 2015 is $18,000 up from $17,500 in 2014. There is a
$6,000 catch-up for employees over 50.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Types of Supplemental Plans
 ROTH plans
 Differ from others in that after-tax funds are contributed to
plan. As a result, withdraws are not subject to tax if you are
age 59.5 and the funds have been invested for five years.
 Roth plans you pay tax first then invest the net of tax
proceeds.
 Traditional plans invest full amount and pay tax when
withdrawn, receiving net amount.
 Advantage depends upon tax rate when contributed v tax rate
when withdrawn. If rate is the same, no difference.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
website or school-approved learning management system for classroom use.
Types of Supplemental Plans
 Keogh and SEP plans
 Designed for small businesses and self-employed
 Maximum you can contribute is 25% of earned income or
$53,000 in 2015
 If withdrawn prior to age 59.5, 10% penalty tax applies
 Normally invested in mutual funds chosen by participant of
the plan
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Types of Supplemental Plans
 Individual Retirement Accounts
 Traditional: before tax dollars contributed
 ROTH: After-tax dollars contributed: Must have AGI under
threshold amount [$193,000 in 2015]
 Advantage depends upon comparison of tax rates now versus tax
rate when retire
 Contribution of each limited to $5,500 in 2015 with an additional
$1,000 if over 50 years old.
 While not for retirement, the Coverdell Education Savings Account
is an IRA for education expenses – income not taxed if use for
qualified education expenses [tuition, books, required fees]
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Annuities
 An investment product created by life insurance companies
that provides a series of payments over time.
 Distributions are part return of investment or cost and part
interest income. May also have survivor benefits if annuitant
has died.
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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Types of Annuities
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Annuities Characteristics
 Contributions: Single premium or installments
 Distributions normally deferred to begin at retirement, may be
immediate distributions
 May be for life or for a term certain
 May have contractual fixed return or be invested with a
variable return
 May be combined with life insurance benefits
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Annuities
 Useful for risk adverse retiree
 May take defined contributions amounts and purchase a fixed
annuity at retirement in provide a stable retirement income
 Transaction costs are high: commission at purchase plus
annual fees to continue
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part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected
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