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Social Security

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Title: Social Security


1
Chapter 19
  • Retirement Planning

2
Chapter 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

3
Chapter Objectives
  • 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

4
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

5
Social Security
  • Qualifying for Social Security
  • You need to accumulate 40 credits from
    contributing to Social Security
  • One credit for each 780 in income per year,
    maximum 4 per year
  • Social Security also available for disabled

6
Social Security
  • Survivors 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 Taxes
  • Collected from both employees and employers
  • 6.2 for Social Security
  • 1.45 for Medicare

7
Social Security
Exhibit 19.1 FICA Taxes on Various Income Levels
8
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.

9
Social Security
  • Retirement benefits
  • Depends on your income and the number of years
    you earned income
  • Provides about 42 of your annual income
  • Eligible for full retirement benefits at age 65
  • You can earn limited income while receiving
    Social Security

10
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

11
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

12
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 employment
  • Vested 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

13
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

14
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

15
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?

16
Financial Planning Online Retirement Expense
Calculator
  • Go to http//moneycentral.msn.com/investor/calc
    s/n_retireq/main.asp
  • This Web site provides an estimate of your
    expenses at retirement based on your current
    salary and expenses.

17
Your Retirement Planning Decisions
  • How to invest your contributions?
  • Use a diversified set of investments
  • Consider the number of years to retirement
  • Consider your level of risk tolerance

18
Your Retirement Planning Decisions
Exhibit 19.2 Typical Composition of a Retirement
Account Portfolio
19
Your Retirement Planning Decisions
Exhibit 19.2 Typical Composition of a Retirement
Account Portfolio
20
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

21
Retirement Plans Offered by Employers
  • Focus on Ethics 401(k) investment alternatives
  • Plans requiring employees to invest their 401(k)
    contributions in their employers stock is
    unethical
  • These contributions should be diversified

22
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
    basis
  • Gradually increasing to 15,000 under Tax Relief
    Act of 2001

23
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 people
  • Employee cannot contribute to this plan
  • Tax and penalty for withdrawals before age 59

24
Retirement Plans Offered by Employers
  • SIMPLE (Savings Incentive Match Plan for
    Employees) Plan a defined-contribution plan
    intended for firms with 100 or fewer employees
  • Employee can contribute up to 6,000 annually and
    the employer can match

25
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
    formula
  • Up to 15 of employees salary, maximum 24,000
    per year

26
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 employees
    retirement account
  • More risky because it is not diversified

27
Retirement Plans Offered by Employers
  • Managing your retirement account after leaving
    your employer
  • Rollover IRA an individual retirement account
    into which you can transfer your assets from your
    company retirement plan tax-free while avoiding
    penalties

28
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 account
  • Up to 25 to a maximum of 30,000 annually
  • Individual determines how funds are invested

29
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

30
Individual Retirement Accounts
  • Traditional IRA a retirement plan that enables
    individuals to invest 2,000 per year
  • Gradually increasing to 5000 under Tax Relief
    Act of 2001
  • Contributions may or may not be tax-deductible
  • Interest earned is tax-deferred
  • Tax and penalty on withdrawals before age 59

31
Individual Retirement Accounts
  • Roth IRA a retirement plan that enables
    individuals who are under specific income limits
    to invest 2,000 per year
  • Gradually increasing to 5000 under Tax Relief
    Act of 2001
  • Income taxed at time of contribution, but not
    when withdrawn

32
Individual Retirement Accounts
  • Comparison of the Roth IRA and Traditional IRA
  • Advantage of traditional IRA over Roth IRA
  • Contributions are sheltered from taxes until
    withdrawn
  • Advantage of Roth IRA over traditional IRA
  • Investment income accumulates tax-free in a Roth
    IRA

33
Individual Retirement Accounts
  • Factors that affect your choice
  • Marginal tax rates at time of contribution and
    withdrawal

34
Financial Planning Online Traditional IRA or
Roth IRA?
  • Go to http//www.financenter.com/products/selli
    ngtools/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.

35
Annuities
  • Annuity a financial contract that provides
    annual payments over a specified period
  • Contributions taxable but gains are tax-deferred
  • Fixed versus variable annuities
  • Fixed annuity an annuity that provides a
    specified return on your investment, so you know
    exactly how much you will receive at a future time

36
Annuities
  • Variable annuity an annuity in which the return
    is based on the performance of the selected
    investment vehicles
  • Annuity fees
  • High fees is a disadvantage of annuities
  • Surrender charge a fee that may be imposed on
    any money withdrawn from an annuity

37
Annuities
  • Also commissions to salespeople
  • Look for no-load annuities that do not charge
    commissions and have low management fees

38
Estimating Your Future Retirement Savings
  • Estimating the future value of one investment
  • Example
  • You consider investing 5,000 this year, and this
    investment will remain in your account until 40
    years from now when you retire. You believe that
    you can earn a return of 10 per year on your
    investment. Using FVIF, you expect the value of
    your investment in 40 years to be

39
Estimating Your Future Retirement Savings
  • Value in 40 years Investment ?
    FVIF(I10, n40)
  • 5,000 ? 45.259
  • 226,295

40
Estimating Your Future Retirement Savings
  • Estimating the future value of one investment
  • Relationship between amount saved now and
    retirement savings
  • If you invested 10,000 instead of 5,000, your
    savings would grow to 452,590 in 40 years

41
Estimating Your Future Retirement Savings
  • Relationship between years of saving and your
    retirement savings
  • If you invested 5,000 for 25 years instead of 40
    years, your savings would be only 54,175

42
Estimating Your Future Retirement Savings
Exhibit 19.3 Relationship between Savings Today
and Amount of Money at Retirement (in 40 years,
assuming a 10 annual return)
43
Estimating Your Future Retirement Savings
  • Relationship between your annual return and your
    retirement savings
  • If you earned a return of 14 instead of 10,
    your 5,000 would be worth 944,400 in 40 years

44
Estimating Your Future Retirement Savings
Exhibit 19.4 Relationship between the Investment
Period and Your Savings at Retirement (assuming
a 5,000 investment and a 10 annual return)
45
Estimating Your Future Retirement Savings
  • Estimating the future value of a set of annual
    investments
  • Example
  • You consider investing 5,000 at the end of each
    of the next 40 years to accumulate retirement
    savings. You believe that you can earn a return
    of 10 per year on your investment. Using FVIFA,
    you expect the value of your investment in 40
    years to be

46
Estimating Your Future Retirement Savings
  • Value in 40 years Investment ? FVIFA
  • 5,000 ? 442.59
  • 2,212,950

47
Estimating Your Future Retirement Savings
  • Relationship between size of annuity and
    retirement savings
  • For every extra 1,000 you can save by the end of
    each year, you will accumulate an additional
    442,590
  • Relationship between years of saving and
    retirement savings
  • If you start saving 5,000 per year at age 25
    instead of age 30 (saving until age 65), you will
    save an additional 857,850

48
Estimating Your Future Retirement Savings
Exhibit 19.6 Relationship between the Amount
Saved per Year and Amount of Savings at
Retirement(in 40 years, assuming a 10 annual
return)
49
Estimating Your Future Retirement Savings
Exhibit 19.7 Relationship between the Number of
Years You Invest Annual Savings and Your Savings
at Retirement (assuming a 5,000 investment and
a 10 annual return)
50
Estimating Your Future Retirement Savings
  • Relationship between your annual return and your
    savings at retirement
  • If you earn a return of 12 instead of 10 your
    savings will accumulate at additional 1.6 million

51
Estimating Your Future Retirement Savings
Exhibit 19.8 Relationship between the Annual
Return on Your Annual Savings and Your Savings at
Retirement (in 40 years, assuming a 5,000
initial investment)
52
Measuring the Tax Benefits From a Retirement
Account
  • Example
  • You wish to invest 5,000 per year in a
    retirement account for the next 40 years. You
    expect to earn a return of 10 per year. Using
    FVIFA, your savings at retirement would be
  • 5,000 ? 442.59 2,212,950

53
Measuring the Tax Benefits From a Retirement
Account
  • If you withdrew all of your money in one year,
    with a 25 tax rate, your tax would be
  • 2,212,950 ? .25 553,238
  • Your income after taxes would be
  • 2,212,950 - 553,238 1,659,712

54
Measuring the Tax Benefits From a Retirement
Account
  • Consider if you invest the 5,000 elsewhere, you
    have an additional 5,000 taxable income each
    year. Assuming a marginal tax rate of 30, you
    have only 3,500 each year to invest. Assume a
    10 return on those savings over the next 40
    years. Using FVIFA, your savings would
    be(contd on next slide)

55
Measuring the Tax Benefits From a Retirement
Account
  • 3,500 ? 442.59 1,549,065
  • You would have a capital gain of
  • 1,549,065 - (3,500 ? 40)
    1,409,065

56
Measuring the Tax Benefits From a Retirement
Account
  • Assuming a capital gains tax of 20, your
    capital gains tax would be
  • 1,409,065 ? .20 281,813
  • Therefore, after 40 years you have
  • 1,409,065 - 281,813 1,127,252
  • With your IRA, your account would be worth over
    500,000 more!

57
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.

58
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?

59
Integrating Key Concepts
60
Integrating Key Concepts
  • Part 1 Financial Planning Tools
  • Part 2 Liquidity Management
  • Part 3 Financing
  • Part 4 Protecting Your Assets and Income
  • Part 5 Investing
  • Part 6 Retirement and Estate Planning
  • In Chapter 19 we learned about retirement
    planning
  • In Chapter 20 we will learn about estate planning
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