C HAPTER 14

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CHAPTER 14Retirement and Estate Planning

“If I knew I was going to live this long, I would have done things a whole lot differently!”

– Oft-heard lament of senior citizens

By 2030, 76 million Baby Boomers will have retired. Only 46 million Gen X’ers will have come up to replace them.

2 Why Think AboutRetirement Planning Now?

People are spending more years (16-20) in retirement

A private pension and Social Security are most often insufficient to cover the cost of living “What private pension plan?!”

Inflation may (not “may” – “will”) diminish the purchasing power of your retirement savings

3 Estimating Retirement Living Expenses Spending patterns will change Some expenses may go down or stop…

Work, clothing, housing, income taxes

But other expenses will probably go up… Medical, leisure, gifts and contributions

Inflation will raise the amount you need to cover your expenses over your probable 16 to 20 or more years in retirement

The tricky wild card is health care. It is the only thing that truly scares Yours Truly with respect to my wife’s and my retirement.

4 How an “Average” Older (65+) Household Spends its Money

Food

Medical

Housing

TransportationClothing

Contributions

Insurance and other

Entertainment

32.5%

11.3%

16.3%16.3%

15.4%15.4%

4.9%

5.7%

7.7%

6.2%

U.S. Bureau of Labor Statistics

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Planning Your Retirement Housing Consider the cost of living and taxes Most people prefer to stay in their homes

6 out of 7 people will remain in their homes “Reverse mortgage” can help supplement income Continuing care retirement communities provide

increasing levels of care Some decide to relocate – Careful!

Research carefully! Rent for a year or two More and more Americans are retiring abroad

“Costa Rica, anyone?” Must still pay Federal income taxes but not state Health care is an issue

If you cancel Medicare, it will be expensive to rejoin

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Planning Your Retirement Income

Most widely used source of retirement income, covering 97% of U.S. workers

Meant to be part of your retirement income, but not the sole source

Check the Earnings & Benefits statement you receive each year

Full retirement benefits at age 65 to age 67, depending on the year you were born

Confidence in Social Security is low

Social SecuritySocial Security

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Social SecuritySocial Security (continued)

(continued)

Year Born Full Benefits Year Born Full Benefits

1938 65 yrs, 2 mos 1955 66 yrs, 2 mos

1939 65 yrs, 4 mos 1956 66 yrs, 4 mos

1940 65 yrs, 6 mos 1957 66 yrs, 6 mos

1941 65 yrs, 8 mos 1958 66 yrs, 8 mos

1942 65 yrs, 10 mos 1959 66 yrs, 10 mos

1943-54 66 years 1960+ 67 years


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Employer Pension Plans - Employer Pension Plans - Defined BenefitDefined Benefit

(continued)

Employer will pay you a certain amount per month when you retire based on your pre-retirement salary, number of years of service and your age at retirement Thank you Southwestern College & CalSTRS

Employer makes the investment decisions for your and their contributions, but your benefit amount stays the same regardless of how the investments perform Unless the fund goes belly up, of course…

Social Security is an example of a defined benefit plan.


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Money-purchase pension plans Percent of your earnings are set aside

Stock bonus plans Employer’s contribution is used to buy stock in your

company for you Profit-sharing plans Employer’s contribution depends on the company’s profits

Salary reduction plans (a.k.a. 401(k), 403(b), etc.) Employer makes non-taxable contributions – the “match” Employee contributions are tax-deferred

Unless your company offers the “Roth 401(k), Roth 403(b)” option

Employer Pension Plans - Employer Pension Plans - Defined ContributionDefined Contribution

(continued)Planning Your Retirement Income

10 Estimating Retirement Living Income Retirement Calculators

Available on many, many financial websites https://www.americanfunds.com/retirement/calculator/index.htm https://www3.troweprice.com/ric/ricweb/public/ric.do

Longevity Calculator http://media.nmfn.com/flash/longevity-game/game.html

Social Security will send you an Estimated Benefits statement upon request www.ssa.gov/estimator They send one to you every year once you reach age 60

Three months before your birthday

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Types of Retirement Accounts Pre-tax Contributions

401(k), 403(b), 457 for private & public employees TSP for Federal employees Traditional IRA for everyone SEP-IRA, SIMPLE IRA, Keogh for self-employed Tax Break Now

Deduct contributions from income tax Pay Taxes in Retirement

Post-tax Contributions Roth IRA for (almost) everyone “Roth 401(k), Roth 403(b)” if company offers it Tax Break Later

Tax-Free in Retirement!

12 Taxable Accounts versus Retirement Accounts

Taxable Account Retirement Account

Stocks Bonds

Mutual Funds

“Cash”Stocks

Bonds

Mutual Funds

“Cash”

Although there are many subtle and not-so-subtle differences, the major differences are how they are taxed by the IRS, how much money

you can contribute, and what you can have in the account.

IRA, 401(k), 403(b), Roth IRA, etc.

Regular account

No limit on contributions Strict limits on contributions

No limits on investment types

Pay taxes every year

Strict limits on investment types

Tax-deferred (Roth IRA – tax-free)

OptionsMargining

ShortingReal Estate

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Individual Retirement Arrangement The most popular personal retirement plan Traditional IRA

Anyone with earned income can contribute to a Traditional IRA

Contributions are normally tax-deductible Unless you have a retirement plan at your employment

and make over a certain amount Contribution limits are increasing

$5,500 in 2014 (Same for Roth IRA – extra $1,000 if 50 or over) Investment grows tax-deferred You pay taxes on the money as you withdraw it once

you are retired. This is normally at age 59½ Mandatory withdrawals begin at age 70½

“What? I thought it stood for Individual Retirement Account!?”

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And the IRA’s Many Cousins… 401(k), 403(b), 457, TSP ($17,500 limit, extra $5,500 if 50+)

SEP IRA – self-employed, small business (25% of your earnings)

Simple IRA – self-employed, small business ($12,000 annual limit, $2,500 if 50 or over)

Simple 401(k) – self-employed, small business Keogh – self-employed, small business Roth IRA – anyone with earned income

Unless you earn too much – limits same as Traditional IRA

Roth 401(k), Roth 403(b) – limits same as 401(k), 403(b)

They all work very much like the Traditional IRA [pre-tax contributions, tax-deferred] except for the Roth IRA, Roth 401(k),

and Roth 403(b) [post-tax contributions, tax-free].

15 A Pre-tax Contribution Lowers Your Taxes Now Example: 401(k) / 403(b)

You contribute via your paycheck: $100

Your Federal tax withholding is lowered by: $25

Your California tax withholding is lowered by: $8

Total government subsidy: $33

Your take home pay is only reduced by: $67

But the whole $100 still goes into your account!

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“So What’s the Catch?” You pay income tax on any amounts

withdrawn in retirement But people in retirement are usually in a lower

tax bracket If not, Congratulations!

If you withdraw the funds before retirement… You pay the income tax, and You pay a 10% penalty

Exceptions for first home purchase ($10,000), higher education, medical disability and financial hardship (hard to get accepted by IRS)

17 A Post-tax Contribution Gives No Tax Break Now Example: Roth IRA

You contribute to a Roth IRA: $100

Your Federal tax withholding is lowered by: $0

Your California tax withholding is lowered by: $0

Total government subsidy: $0

Your disposable income is reduced by: $100

So Why Contribute to a Roth IRA?

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“Because a Roth IRA is So Cool!”

Tax-Free in Retirement is a Golden Opportunity No other investment choice comes close Eventually, they will probably be gotten rid of

Plus, you can withdraw the contributions at any time with no penalty You have already paid tax on the contributions

This makes the Roth IRA also an excellent intermediate-term investment account Purchase of a house or other high-ticket item Great for college expenses

Currently not used in Financial Aid calculations

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Limitations on Roth IRAs Contributions Only single taxpayers with an AGI of $114,000 or

less in 2014 and married couples with an AGI of $181,000 or less in 2014 can fully contribute to a Roth IRA If you don’t qualify, Congratulations!

But you can contribute to a Roth IRA anyway If you find that you have made over the limit, you

can “recharacterize” the contributions into a Traditional IRA (which does not have the same limitations) before you file your taxes

And then you convert the Traditional IRA to a Roth I know. I know. Who voted for these bozos?

Oh, yeah. We did…

But a Roth IRA is not for everyone(Yes, it is. You just have to learn how to navigate the paperwork.)

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Tax Credit for Low Income Earners

Up to 50% of contributions Maximum of $2,000 Based on Adjusted Gross Income

$30,000 or less – single filers $60,000 or less – married filing jointly $45,000 or less – head of household

Reminder: A tax credit is a dollar for dollar reduction of income taxes

If you do your own taxes, don’t forget this. If you have someone do them, make sure to remind them you made

contributions to a retirement account.

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“Roth 401(k)” / “Roth 403(b)” If your employer offers the option, you are

able to place after-tax dollars into your 401(k) or 403(b) accounts

Post-tax contributions like a Roth IRA Although contributions can not be taken out

without penalty or taxes (as can be done with a Roth IRA)

This option is popular with workers in lower tax brackets. They don’t need the tax break now. They are not quite as good as the

Roth IRA unless your company matches your contributions. If your company matches your contributions, the Roth 401(k) is the winner.

22 Anticipated Sources ofRetirement Income

Social Security Administration

Social Security

Pension

Part-time work

Spouse’s pension

Savings

12%12%

27%27%

Other9%9%

401(k) 7%7%

7%7%

18%18%

IRA

8%8% Home equity5%5%

7%7%

23 The “Baby Boomer” Generation Retirement Time Bomb

Between 1940 and 2010, average lifespan has increased by 15 years, while

The retirement age for Social Security has increased only two years

In 1940, there were very few retirees per worker Most workers, particularly men, simply did not live to 65

Now, not only do most workers reach retirement, their retirement lasts an average of 16-20 years

Every day for the next 20+ years, 10,000 people will have their 65th birthday

We Have a Serious Problem


1940 30 workers for every 1 retiree 30 to 1

2010 3 workers for every 1 retiree 3 to 1

2050 1.5 workers for every 1 retiree 1.5 to 1

(continued)

Ratio of Workers to Retirees


Two-worker families became the norm (30:1 15:1)

Plus productivity gains have been substantial, and Quite simply, as the number of retirees grew, The number of children per worker diminished

Therefore, the ratio of workers to dependents has stayed roughly the same

The only difference is that the dependents have shifted from children to the elderly

(continued)

But how did we manage to go from 30 workers per retiree down to 3 workers per retiree without significant economic upheaval?


Baby Boomers are not saving enough for their retirement “Unless a big bucket of cash falls out of the sky, I’m

going to be working until I die.” There will not be enough workers to service the

economy Let alone provide the health care and other services

that the retirees will demand Recall: The average person between ages 60 and 70

uses more medical resources than they did between ages 0 and 59

1/3 of all Medicare dollars are spent in the last year of life

(continued)

The Problem is Two-fold

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Possible Solutions – Financial

Aggressive saving by Boomers Yeah, Right… Everyone over 50 should be socking away the

new maximum limits into their 401(k)’s, IRA’s, etc. But unfortunately, it jest ain’t happenin’

Raising Social Security taxes Removing the $117,000 limit on Social Security

taxes for the wealthy Older people have traditionally more sway with

politicians Recipe for intergenerational warfare Taxes would essentially have to double

From 8% up to 16% 3 workers down to 1.5 workers

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Lowering Social Security benefits Again, seniors have traditionally more sway with

politicians Yet another recipe for intergenerational warfare The previous administration’s 2005 proposal would

have reduced benefits by up to 49% for many workers over the next several decades Would have hit the middle class the hardest

Surprise!

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Investing Social Security in the stock market Ya’ don’t hear too much about this one anymore

since the stock market plummeted Fall of 2008 Will be very, very costly

Estimates range from between $2½ to $4½ trillion dollars

Since the pensions of current beneficiaries will still need to be funded

However, …

(continued)

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An economy consists of both supply and demand Let’s assume Boomers saved enough for their

retirement (In other words, there is enough demand)

If there are not enough goods and services to service the demand, (In other words, there is insufficient supply)

The result will be large-scale inflation of goods and services or large-scale deflation of financial assets, or both

Financial solutions alone will not work

(continued)

“Huh? What?”

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If I save more than everyone else, then I can retire without a problem There will be enough goods and services to supply my

needs If everyone saves more, then everyone will want

the same goods and services Everyone will all be bidding up the prices of health

care, leisure, retirement housing, etc. Or everyone will have to accept lower prices for

our saved financial assets since everyone would be trying to sell them at the same time to pay for the same goods and services

Most likely, both actions will occur somewhat

(continued)

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Possible Solutions – Economic

Increased productivity Same problem as increasing Social Security taxes Must be shared with post-Boomers Will help economy substantially, but not necessarily

the goods and services that retirees need Increased Developing World trade

The next engine of world economic growth? But retirement goods and services are not easily

traded across the globe Health care, golf memberships, assisted-care housing,

etc. Remember the “Surgery Vacations”?

Reallocation of the work force Health care, Health care, Health care

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Possible Solutions – Demographic

Increased immigration Ever visited a nursing home or assisted-living facility? But to maintain the same ratio of workers to retirees,

we would need approximately 85 million immigrants

Increased retiree emigration “Costa Rica, anyone?” But again, the numbers are mind-numbing

120,000 retirees leaving each month for the next 30 years would keep the above ratio intact

The above two scenarios will help somewhat But not significantly

So how we gonna’ do it?

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Possible Solutions – Demographic

Raising the retirement age! To maintain the current ratio of workers to retirees, we

would need to raise the accepted retirement age to 72 or 73 by the year 2030

This will happen If not mandated, retirement will simply become

unaffordable or unavailable to more and more workers It is already happening!

Retirees are returning to the work force Their health is good; they want to be productive Businesses are accommodating older workers

Fewer hours, more flexible work schedules

(continued)

You are now hearing politicians saying that we need to raise the retirement age. Before 2010, no politician would have dared say

anything like this for fear of being lynched!


We have faced serious problems before The American economy is extremely resilient The American people are extremely resourceful

A combination of some or all the previous possible solutions will be implemented, with or without formal planning and consensus Although we Americans are very resilient and

resourceful, we tend to be horrible at planning We will indeed be living in “interesting times”

Are you familiar with the ancient Chinese curse? “May you live in interesting times”

We Will Solve This Problem

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Retirement – The Bottom Line

Expect on living much longer than you ever thought you would “Yippee! Hurray!”

Expect on working much longer than you ever thought you would “Boo! Hiss!”

Start saving now! “Grumble. Bitch. Gripe.”

The Nature of Retirement will Change

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What is Estate Planning? Your estate consists of everything you own An estate plan is how you set up to administer

and distribute your property during your life (gifts) or after your death (inheritance)

Estate planning is not just for the wealthy If you own a home or have children, you need

estate planning Not to be construed as legal advice…

Estate planning includes both building your estate, and also transferring your estate upon your death “Death and Taxes” We’ve already done taxes.

Now’s the time for to do da’ death thing.

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What is Estate Planning? Most people give little or no thought to putting

their personal and financial affairs in order for

their families that survive them Naming a guardian Distribution of personal belongings

Demands of daily living can keep people from thinking about death Plus it just ain’t fun to think about your own

mortality!

(continued)

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What is Estate Planning? Plan while you are in good health

Many people procrastinate Until some life-threatening illness or near-death

accident scares them into acting

Estate planning is especially important for non-traditional households and businesses Unmarried partners “Happy” relationships Business partnership relationships

(continued)

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Estate Planning: Should You? Hire a lawyer?

Expect to pay between $200 to over $1,500 $200 for a will, $500 to $1,500 for a trust

Go it alone? Books, software, pre-printed forms Many, many Internet sites designed to help you

nolo.com doyourownwill.com hrblock.com legalzoom.com

What did we say about taking out your own appendix? Get a good referral!

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What Estate Planning Involves Create, review, and update your will/trust/etc. on a

regular basis, especially if you get married, divorced, or move to another state A codicil is a document used to amend an existing estate

document Name an executor for your estate Consider creating and managing a trust or trusts

Most all Californians would benefit from a trust Not to be construed as legal advice…

Prepare a letter of last instructions No legal standing but can be very helpful

Organize current financial records and documents, and let family members know where they are!

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Make an Inventory of Your Estate

Financial investments, retirement accounts Your home and any other real estate Business interests Insurance policies Antiques, art, collections, cars

Titles to the vehicles

Important documents Social Security Veteran documents

Remember your net worth statement?

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A will is the legal declaration of a person’s mind as to the disposition of his or her property after death

Marriage and divorce affect your will Marriage may revoke your will depending on the

state you live in Review your will with an attorney if you marry or

divorce. You will probably want a new one anyway Legal costs to prepare a will vary with how

complex it is A standard will costs between $200-$500 dollars

Wills

Although I don’t personally recommend it, you could probably do your own will without creating a legal nightmare for your heirs.

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Intestate and Probate Intestate

Means you die without a will The state distributes your assets The state will decide on a guardian for your

children Very complicated if you also have a “blended”

family Probate

Probate court validates wills and makes sure your debts are paid

Often, people try to avoid the probate process by using a living trust (more later)

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Choosing an Executor Find out if the executor is willing to accept

this major responsibility Find out if he or she is capable and

trustworthy If you don’t name one, the court will name

one for you – not the best alternative!Being an executor is a serious responsibility. Choosing an executor is an even more serious task. Consider choosing co-executors, your

attorney or a trust company and a friend or family member. Make provisions to pay the friend for their time. Your friend can do the leg

work for $50 to $75 per hour. The attorney will make sure the important tasks are done correctly (at $175 to $250 per hour).

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Responsibilities of an Executor

Takes control of assets of the estate Files an inventory of assets and liabilities

with the court Sells assets if necessary to pay liabilities Distributes assets, based on the instructions

in the will Makes a final accounting to the court

The executor or co-executors have enormous power. There are countless stories of abuses of that power.

Choose carefully.

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Selecting a Guardian Even if you don’t have much assets, if you

have a child or children, you still need a will to at least name a guardian1

The guardian assumes the responsibility for providing the child or children with personal care and managing the estate for them

Be sure the person is willing and able to raise them

See if their values and child rearing practices match yours 1Not to be construed as legal advice…

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Prenuptial Agreement Waives rights to each other’s property that

was acquired before the marriage Agree on a settlement if you should divorce Very important for couples who already

have children or assets or both At least talk to a lawyer about the advantages

and disadvantages of a prenuptial agreement before getting married

And if your would-be spouse refuses to even discuss a prenuptial agreement, that should serve as a disturbing omen… Don’t say I didn’t warn you!

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A Living Will Provides for your wishes to be followed if

you become so physically or mentally disabled that you are unable to act on your own behalf

Discuss your living will with those close to you

Sign and date it before two witnesses Give copies to those close to you Requires careful thought

Actually, it’s a no-brainer! (Sorry, could not help myself…)

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Power of Attorney Power of attorney

Legal document authorizing someone to act on your behalf

Can be limited or gives a great deal of power

Durable power of attorney for health care If you are unable to make decisions regarding

your health care this authorizes someone to do it for you

Again, as with the executor of your estate, choose carefully who you give power of attorney to. They will

be in control of your assets.

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Letter of Last Instruction Not legally enforceable Provides heirs with information Should include...

Your funeral preferences Names of people you want notified Location and contents of safe deposit box Assets and debts Who gets personal effects that are of little value

Avoids having the lawyers and the courts to deal with it (and charging you their hourly rate!)

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What is a Trust? A trust is a legal arrangement through which

a trustee holds your assets for your benefit or that of your beneficiaries Takes care of or manages your property In some trusts, you are the trustee Distributes your assets to your heirs from the

trust after you die according to your instructions All assets are taken out of your name and

put in the name of the trust or trustsTrusts are tricky. Some people create them for themselves. You can

do this but if you screw up, your actions can result in outcomes that range from (typically) useless to (potentially) disastrous.

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Possible Benefits of a Trust Avoid probate!

More later about probate and California

Can reduce estate taxes Frees you from managing assets

Or you can be the trustee of your own trust and you manage the assets

Provide income for a surviving spouse Or other dependents

Trusts can be extremely helpful for people whose children or grandchildren are either disabled or emotionally

unprepared for a windfall inheritance.

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Types of Trusts Revocable living trust

or Inter vivos trust Credit-shelter trust Disclaimer trust Marital-deduction

trust Self-declaration trust Testamentary trust Grantor-retained

annuity trust Private Annuity Trust

A/B Trusts Life insurance trust Charitable remainder

trust Qualified personal

residence trust Generation-skipping

trust Spendthrift trust

Asset Protection Trust

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California and Living Trusts Revocable Living Trusts, A/B Trusts, etc.

Very common in California Used to avoid probate and reduce estate taxes

If you are a California resident who owns property or has any substantial net worth, your estate will most likely benefit from some sort of living trust Not to be construed as legal advice…

Legal fees range from $500 to over $1,500 Please do not try to do your own trust – Why?

Let’s say it again: If you screw up, your actions can result in outcomes that range from useless to disastrous.

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Probate Costs in CaliforniaGross Asset

Value of EstateMinimum

Probate FeesProbate Fees

with Living Trust

$200,000 $14,000 $0

$300,000 $18,000 $0

$400,000 $22,000 $0

$500,000 $26,000 $0

$750,000 $36,000 $0

$1,000,000 $46,000 $0

$2,000,000 $66,000 $0

Assuming you find a good lawyer to set up the trust correctly!

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Federal and State Estate Taxes

Federal estate tax Estate and trust federal income taxes State inheritance tax Gift tax Tax avoidance versus tax evasion Charitable bequests

Reduces the size of the estate Double tax break – before and after death

Paying tax owed Often assets must be sold to pay for the tax

Plan ahead to avoid this (there are many options)

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Federal Estate Taxes ExclusionYear Exclusion Maximum Rate

2012 $5,120,000 35%

2013 $5,250,000 40%

2014 $5,500,000 40%The Republicans want the estate tax to be repealed permanently. They

refer to it as the “death tax.” Winston Churchill described it as “a certain corrective against the development of a race of idle rich.”

It affects about 0.14% of all Americans, far less than the top 1%.http://www.cbpp.org/files/estatetaxmyths.pdf

“Our ideals, laws and customs should be based on the proposition that each generation in turn becomes the custodian rather than the absolute

owner of our resources - and each generation has the obligation to pass this inheritance on to the future.”

-- Alberto Moravia (also attributed to Charles Lindburgh)

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Speaking of Inheritances… The Greatest Transfer of Wealth in the

History of the World Will begin shortly

$41 trillion in the next 50 years $6 trillion in taxes

Only a small number of estates will be affected But many of them are in the tens of billions of

dollars 2/3 of it will go to people who are already

wealthySo, if you are one of the lucky ones who will be the

recipients of an inheritance…

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Dealing with a Windfall You suddenly receive $300,000

or $500,000 or $800,000 or $1,200,000 or whatever

You think you are now one of the rich and wealthy You Are Set For Life!

Or are you?

The Average Joe or Jane Lottery Winner whose life was ruined by winning the lottery has become a cliché.

“It was a fun three years.” What would you do with a windfall?

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Dealing with a Windfall Change Your Lifestyle Very Little!

Be careful of acquiring a sense of responsibility for family and friends – and even strangers! They will often expect you to share your windfall

with them

Consider not touching the money for six months

Find a trusted financial advisor

Whatever you do, realize that this is it. This is the one and only inheritance you will receive from your Dear Grand-Aunt

Trudy. Don’t squander it.

(continued)

62 The Final Instruction regarding Estate Planning

And for BUS-121 Financial Planning and Money Management

Summer 2014

Go See A Lawyer Get a good reference

C HAPTER 14

Documents

Transcript of C HAPTER 14