©2012, College for Financial Planning, all rights reserved.

Module 7Retirement Planning

Foundations In Financial PlanningSM Professional Education Program

Learning Objectives

7–1: Describe regulations and characteristics of IRAs and tax-deferred annuities.

7–2: Describe regulations and characteristics of defined benefit plans.

7–3: Describe regulations and characteristics of noncontributory defined contribution plans.

7–4: Describe regulations and characteristics of contributory defined contribution plans.

7–5: Differentiate regulations and characteristics of various retirement plans.

7–6: Calculate a given person’s retirement income needs.

7–7: Identify reasons why a person delays saving for retirement.

7–8: Describe typical asset allocations during the savings years.

7–9: Describe potential pitfalls associated with retirement savings and retirement funds.

7–10: Identify common sources of retirement income.

7–11: Describe factors affecting distributions from individual and employer-sponsored retirement plans.

7–12: Describe factors affecting retirement account withdrawal rates.5-2

Questions To Get Us Warmed Up

7-3

Contributory IRAs

• Eligibilityo up to age 70½ for non-Roth IRAso no age restriction

for Roth IRAso earned incomeo lesser of $5,000 or

100% of earned income

• Deadlineso April 15 for prior tax

year contribution• Earnings grow tax

deferred

• Deductibility7-4

Spousal IRAs

• Up to $5,000 contribution• Must file jointly• Combined joint income must equal or

exceed IRA contribution amounts

7-5

Rollover IRAs

• Purpose: to transfer assets from one custodian to another custodiano 60-day rollover

• IRS reporting• one per custodian per year

o Direct transfer• no IRS reporting• one rollover per year rule does not apply

• Be aware of commingling

7-6

Direct Rollover IRAs

Direct Transfer Rollover• For distributions directly

from an employer-sponsored retirement plan

• Avoids 20% withholding• 60-Day Rule does not apply

to direct rollovers

7-7

Roth IRAs

• Provides tax-free growth & withdrawal• Contributions limited to lesser of $5,000

or 100% earned income• Contributions after age 70½ are

permitted • Qualified distribution rules• Deductible IRA conversions

7-8

Coverdell Education Savings Accounts

Formerly called Education IRAs

• Elementary, secondary and higher education expenseso Unlike 529 plans, Coverdell accounts can be

used to pay for qualified expenses at the elementary and secondary levels.

• Contribution limit of $2,000 per student annually

• Distributions less than or equal to education expenses not included in gross income nor subject to 10% additional tax

• Distributions must be made by age 30

7-9

Annuities

Compare with IRAs

7-10

Defined Benefit Plans

• Provide specific benefits at retiremento current contribution amounts

determined by plan actuary• Contributions are deductible by the

employer and excluded from income for the employee

• Earnings grow tax-deferred

7-11

Defined Contribution Plans

• Set contribution amounts for pension plans; discretionary for profit sharing plans (unknown benefit amounts)

• Noncontributory versus contributory

plans

7-12

Employer-Sponsored Retirement Plans

• Maximum vesting schedules• Defined contribution plans

o three-year ‘cliff’ vestingo six-year graded vesting

• Defined benefit planso five-year ‘cliff’ vestingo seven-year

graded vesting

7-13

Profit Sharing Plans

• Percentage contributions may vary from year to year.

• Eligibility requirements are: age 21 and one or two years of service

• Employer contribution percentage are limited to 25% of total compensation for all participants.

• Contributions may be same percentage for all employees, or may be age-weighted, cross-tested, take into account service, or be integrated with Social Security.

7-14

Money Purchase Plans

• Fixed contribution percentage; same percentage for all employees

• Required annual contributions

• Employer contribution percentage limited to 25% of total compensation for all participants

7-15

SEP IRA

• Employer makes IRA contributions for the employees

• Contributions limited to the lesser of 25% of employee compensation or $50,000 (2012)

• An employee’s plan compensation limited to $250,000 (2011) for nonelective contributions, but not limited for matching contributions

• Similar to a profit sharing plano less administrationo 100% vesting

7-16

401(k) Plans

• Deferralso elective contributions

• limited to $17,000 in 2012• age 50 or older employee catch-up contributions

limited to $5,500 in 2012• Employer tax deduction for contributions

(excluding EE elective deferrals) limited to 25% of total taxable compensation of all employees

7-17

401(k) Plans

• Annual additions for each employee limited to lesser of 100% of compensation or $50,000 (2012)o Annual additions include ER and EE

contributions, EE after-tax contributions, and forfeitures.

o Annual additions do not include catch-up contributions.

• Loan provisions

7-18

403(b) Plans

• For tax-exempt organizations• Similar to a 401(k)• Elective deferrals limited to $17,000 in

2012• Matching contributions available• Age 50 or older employee catch-up

contributions are limited to $5,500 (2012)

• Special catch-up provisions available in addition to age 50 or older catch-up contributions

7-19

SIMPLE IRA

• Available to employers with 100 or fewer employees

• Employee elective contributions limited to $11,500 in 2012

• Employer must contribute• Less administration

7-20

Comparing the Plans

• Who contributes: employee and/or employer?

• Eligibility requirements• Contribution limits• Tax features

7-21

Other Plans

• Thrift plans• Age-weighted profit sharing plans• Cross-tested profit sharing plans• Stock bonus plans• ESOPs and LESOPs• Target benefit plans• Cash balance pension plans

7-22

Changing Factors in Retirement Planning

• Social Security issues• Employer-sponsored pension plans• Increasing longevity

7-23

Why Delay Saving for Retirement?

• Procrastination• Confusion about how to start• Poor cash management• “I’m too young to worry yet”• Other immediate priorities• “The money is locked up for too long”

7-24

Calculating Retirement Needs

7-25

Today

1.Inflate One Payment Rate of Inflation

3. Discount Step 2 ResultDiscount (Investment) Rate

2. PVAD Serial PMT Calculation Inflation-Adjusted Rate (BEG)

Future

1001ratelationinf1

returntax -after1

Inflation-Adjusted Interest Rate

7-26

Retirement Needs Calculation: Step 1

When Kim retires in 15 years, she wants to receive the equivalent of a retirement income

of $50,000 at the beginning of each year.

She also wants the income to adjust annually for inflation. Kim believes that inflation will average 4% and that she can earn 7% on her investments. Assuming she wants to plan for 25 years of retirement, how much will Kim need to invest today in order to provide the desired income?

7-27

HP-10B/10BII

50,000 PV

4 I/YR

15 N

FV

+/–

Answer 1: $90,047

Retirement Needs Calculation: Step 2

7-28

Answer 2: $1,634,171

1.07 –

HP-10B/10BIIset to Begin

100

90,047 PMT

N

= I/YR

1

25

PVAD

1.04

+/–

Retirement Needs Calculation: Step 3

7-29

Final Answer: $592,300

HP-10B/10BII

1,634,171 FV

7 I/YR

15 P/YR

PV

+/–

Retirement Saving Problems

• Higher job turnover = more lump-sum distributions (LSDs)o older workers less likely to consume

LSDs than younger workerso older workers generate larger

LSDs than younger workers• Loan provisions

used unwisely

7-30

Sources of Income Among Retirees

• Social Security• Employer plans• Personal savings• Employment

7-31

Retirement Plan Distribution Rules

• IRAs• Annuities• Employer-sponsored plan distributions

7-32

Withdrawal Rates During Retirement

• Personal factorso healtho life expectancyo income levelo housingo activities

• Asset allocation• Taxes

7-33

Question 1

John Snow, age 56, recently changed jobs and requested that his entire 401(k) plan balance of $100,000 be sent directly to him. John plans to open an IRA to hold the money once he receives the funds. The plan administrator will send John a check for which one of the following amounts?a. $20,000b. $50,000c. $80,000d. $100,000

7-34

Question 2

Ned has been a participant in Winterfell Amusement’s defined benefit plan for four years and wants to know what amount of his retirement benefit is vested. You check the plan documents and find that Winterfell Amusement uses a seven-year graded vesting schedule. What do you tell Ned?a. You are 20% vested.b. You are 40% vested.c. You are 60% vested.d. You are 80% vested.

7-35

Question 3

Jack borrowed $8,000 from his 401(k) plan to buy a certified pre-owned car. How long does Jack have to pay back the $8,000?a. 1 yearb. 5 yearsc. 15 yearsd. It must be paid off completely by the

time he separates from service.

7-36

Question 4

There are many assumptions that must be made in creating a retirement plan. Which of the following does not require an assumption to be made to do the calculations for forecasting retirement income needs?a. rate of inflationb. after-tax rate of return on investmentsc. number of years in retirementd. Social Security cost of living

adjustment (COLA)

7-37

Question 5

Gordon is 55 and has worked all of his life as a plumber. He’s tired of the crap and wants to retire. What is the earliest age a person can begin receiving Social Security retirement benefits based on their own work history?a. 60b. 62c. 65d. It depends on the year they were born.

7-38

Question 6

Jason is 45 and has contributed $5,000 per year to a Roth IRA for the last 10 years. The account balance is now $65,000 and Jason wants to withdraw the entire balance to purchase a night club. What will be the tax consequences of the withdrawal?

a. Jason will pay ordinary income taxes on the entire $65,000.

b. Jason will pay ordinary income taxes on the entire $65,000 plus a 10% penalty.

c. Jason will pay ordinary income taxes on $15,000 of the distribution.

d. Jason will pay ordinary income taxes on $15,000 of the distribution plus a 10% penalty.

e. There will be no tax consequences because Jason is using the funds to purchase a business.

7-39

Question 7

What will be the financial impact of 3.5% inflation over 20 years on a retirement distribution budget?a. Purchasing power will approximately

double.b. Purchasing power will approximately

be cut in half.c. A conservative investment return will

more than compensate for inflation.d. No real impact.

7-40

©2012, College for Financial Planning, all rights reserved.

Module 7End of Slides

Foundations In Financial PlanningSM Professional Education Program