Dr. Steven M. Hays

BKHS

Personal Finance1

Objectives

Describe the role of Social Security Explain the difference between defined-

benefit and defined-contribution retirement plans

Present the key decisions you must make regarding retirement plans

Introduce the retirement plans available for self-employed individuals

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Objectives - continued

Describe types of individual retirement accounts

Illustrate how to estimate the savings you will have in your retirement account at the time you retire

Show how to measure the tax benefits from contributing to a retirement plan

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Social Security

Social Security is a federal program that taxes you during your working years and uses the funds to make payments to you upon retirement

It does not provide adequate income to solely support most people

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Social Security

Qualifying for Social SecurityYou need to accumulate 40 credits from

contributing to Social Security○ One credit for each $780 in income per year,

maximum 4 per yearSocial Security also available for disabled

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Social SecuritySurvivor’s benefits are also provided

○ A one-time income payment to the spouse

○ Monthly income payments if spouse is older than 60 or has a child under the age of 16

○ Monthly income payments to children under age 18

Social Security TaxesCollected from both employees and employers

○ 6.2% for Social Security

○ 1.45% for Medicare

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Social Security

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Exhibit 19.1: FICA Taxes on Various Income Levels

Financial Planning Online: Request a Social Security Statement

Go to: http://www.ssa.gov/top10.html This Web site provides a form that you

can use to request that a statement of your lifetime earnings and an estimate of your benefits be mailed to you.

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Social Security

Retirement benefitsDepends on your income and the number

of years you earned incomeProvides about 42% of your annual incomeEligible for full retirement benefits at age 65You can earn limited income while receiving

Social Security

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Social Security Concern about

retirement benefits in the future Retirees are living

longer which costs the program more in benefits

The number of retirees continues to grow

Many people are relying less on Social Security and establishing their own retirement programs

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Employer-Sponsored Retirement Plans Designed to help you save for retirement Employees and/or employers contribute A penalty is imposed for early

withdrawal Your contributions are tax-deferred

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Employer-Sponsored Retirement Plans

Defined-benefit plan: an employee-sponsored retirement plan that guarantees you a specific amount of income when you retire based on your salary and years of employmentVested: having a claim to a portion of the money

in an employer-sponsored retirement account that has been reserved for you upon your retirement even if you leave the company

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Employer-Sponsored Retirement Plans Defined-contribution plan: an employer-

sponsored retirement plan that specifies guidelines under which you and/or your employer can contribute to your retirement account and that allows you to invest the funds as you wish

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Employer-Sponsored Retirement Plans

Benefits of a defined-contribution plan○ Money contributed by

employer is like extra income

○ Encourages employees to save

○ Offers tax deferred income

Investing funds in your retirement account○ Employer can usually

choose from a number of different funds

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Your Retirement Planning Decisions

Which retirement plan should you pursue?An employer-sponsored plan is usually the best

choice if your employer contributes

How much to contribute?As much as you can as early as you can!How much to save?

○ How many people will you be supporting?○ What do you expect prices to be?○ What is your estimated life expectancy?

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Financial Planning Online: Retirement Expense Calculator

Go to: http://moneycentral.msn.com/investor/calcs/n_retireq/main.asp

This Web site provides an estimate of your expenses at retirement based on your current salary and expenses.

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Your Retirement Planning Decisions How to invest your contributions?

Use a diversified set of investmentsConsider the number of years to retirementConsider your level of risk tolerance

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Your Retirement Planning Decisions

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Exhibit 19.2: Typical Composition of a Retirement Account Portfolio

Your Retirement Planning Decisions

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Exhibit 19.2: Typical Composition of a Retirement Account Portfolio

Retirement Plans Offered by Employers 401(k) plan: a defined-contribution plan

that allows employees to contribute a maximum of $10,500 per year or 15 percent of their salary on a pre-tax basis Amount of contribution gradually increasing

to $15,000 under Tax Relief Act of 2001 Matching contributions by some employers Tax on money withdrawn from the account

○ Tax and penalty for withdrawals before age 59½

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Retirement Plans Offered by Employers Focus on Ethics: 401(k) investment

alternativesPlans requiring employees to invest their

401(k) contributions in their employer’s stock is unethical

These contributions should be diversified

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Retirement Plans Offered by Employers 403-b plan: a defined-contribution plan

allowing employees of non-profit organizations to invest up to $10,000 of their income on a tax-deferred basisGradually increasing to $15,000 under Tax

Relief Act of 2001

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Retirement Plans Offered by Employers Simplified Employee Plan (SEP): a

defined-contribution plan commonly offered by firms with 1 to 10 employees or used by self-employed peopleEmployee cannot contribute to this planTax and penalty for withdrawals before age

59

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Retirement Plans Offered by Employers SIMPLE (Savings Incentive Match Plan

for Employees) Plan: a defined-contribution plan intended for firms with 100 or fewer employeesEmployee can contribute up to $6,000

annually and the employer can match

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Retirement Plans Offered by Employers Profit sharing: a defined-contribution

plan in which the employer makes contributions to employee retirement accounts based on a specified formulaUp to 15% of employee’s salary, maximum

$24,000 per year

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Retirement Plans Offered by Employers Employee Stock Ownership Plan

(ESOP): a retirement plan in which the employer contributes some of its own stock to the employee’s retirement accountMore risky because it is not diversified

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Retirement Plans Offered by Employers Managing your retirement account after

leaving your employerRollover IRA: an individual retirement

account into which you can transfer your assets from your company retirement plan tax-free while avoiding penalties

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Retirement Plans for Self-Employed Individuals

Keogh Plan: a retirement plan that enables self-employed individuals to contribute part of their pre-tax income to a retirement accountUp to 25% to a maximum of $30,000

annuallyIndividual determines how funds are

invested

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Retirement Plans for Self-Employed Individuals Simplified Employee Plan (SEP)

Also available for self-employed who can contribute up to 15% of annual income to a maximum of $24,000 annually

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Individual Retirement Accounts Traditional IRA: a retirement plan

that enables individuals to invest $5,000 per yearIf over age 50, $6,000 per yearContributions may or may not be tax-deductibleInterest earned is tax-deferredTax and penalty on withdrawals before

age 59

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Individual Retirement Accounts Roth IRA: a retirement plan that enables

individuals who are under specific income limits to invest $5,000 per yearIncreases to $6000 if over age 50Income taxed at time of contribution,

but not when withdrawn

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Individual Retirement Accounts Comparison of the Roth IRA and

Traditional IRA

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Individual Retirement Accounts

Factors that affect your choice○ Marginal tax rates at time of contribution

and withdrawal

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Financial Planning Online: Traditional IRA or Roth IRA? Go to:

http://www.financenter.com/products/sellingtools/calculators/ira/

Click on: “Should I convert my IRA into a Roth IRA?”

This Web site provides an analysis of whether a Traditional or a Roth IRA is better suited to you.

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Annuities Annuity: a financial contract that provides

annual payments over a specified period Contributions taxable but gains are tax-

deferred

Fixed versus variable annuitiesFixed annuity: an annuity that provides a

specified return on your investment, so you know exactly how much you will receive at a future time

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AnnuitiesVariable annuity: an annuity in which the

return is based on the performance of the selected investment vehicles

Annuity feesHigh fees is a disadvantage of annuitiesSurrender charge: a fee that may be

imposed on any money withdrawn from an annuity

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AnnuitiesAlso commissions to salespeopleLook for no-load annuities that do not

charge commissions and have low management fees

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Financial Planning Online: How to Build Your Retirement Plan Go to:

http://www.quicken.com/retirement/planner/ This Web site provides a framework for

building a retirement plan based on your financial situation.

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How Retirement Planning Fits within Your Financial Plan Key decisions about retirement planning

for your financial plan are:Should you invest in a retirement plan?How much should you invest in a

retirement plan?How should you allocate investments

within your retirement plan?

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Integrating Key Concepts

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The Big Question ?

Have you started to plan for your future?

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