CHAPTER 14

Retirement Planning:

Concepts and Strategies

Chapter 14: Retirement Planning 1

INTRODUCTION Americans have relied on the venerable three legged stool to

provide for their retirement:

Social Security Benefits Private Pensions Personal Savings

Many factors currently threaten the stability of this stool:

Longer Lives Possible Reduction of Social Security Benefits Doubtful Viability of Many Corporate Plans

Need for Increased reliance on private resources is the obvious result

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INTRODUCTION (Contd.)

In retirement planning: Individuals first define their goals for

quality of life after retirement

Next, they measure their ability to meet their goals, and develop strategies for improving their performance

Finally, success in retirement planning is assured if the individual is able to retire at the desired retirement age with the expected level of income

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RETIREMENT BUDGET Retirement Expenditure Analysis

Analyze client’s current expenditures (Table 14-1 provides example for a hypothetical couple)

Following approaches can be used to arrive at retirement budgets

One approach applies the accepted rule of thumb that a retiree is likely to spend 60% or 70% of the pre-retirement expenditure level

A better approach is to divide fixed and flexible expenditures into several key categories and encourage the client to estimate the retirement expenditure in each category

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RETIREMENT BUDGET (Contd.)

Retirement Income

Potential Shortfall Analytical framework for calculating savings required for

retirement is presented in Table 14-2.

Strategies to solve the potential shortfall problem can be divided into three categories:

1. Tax-Advantaged Investment Planning2. Savings Planning

3. Asset Repositioning Planning

The Potential Surplus

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Retirement Income Needs Analysis

Figure 14-1 Retirement Income Needs Analysis

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Process

Determine future income need Determine amount of funds needed

to cover income need Forecast retirement information

1) What do I need to invest to get the amount

2) Given my current program, what return do I need to achieve my goals

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Determine future income need

Use the 60 – 70% of gross rule (+ or -) Need to estimate life span; return

during retirement; year of retirement Assume taxes same in retirement as

now DOES THIS SEEM LIKE A FAIR

ASSUMPTION???

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CURRENT EARN 75,000 GROSS; AGE 25; RETIRE AT AGE 60; INFLATION 4%; ESTIMATE WILL NEED 75% OF INCOME DURING RETIREMENT

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AMOUNT NEEDED ANNUALLY TO LIVE DURING RETIREMENT AT SAME LIFESTYLE

Determine amount of funds needed to cover income need ESTIMATE THAT WILL LIVE TO BE 80 YEARS OLD; INFLATION DURING RETIREMENT 4%. RETURN OF INVESTMENTS 8%

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Amount needed in retirement accounts to live at desired level

Amount needed if we incorporate inflation during retirement years

Forecast retirement information

1) what do I need to invest to get the amount

Currently have $10,000 in my accounts; return will average 10%; Currently invest $500 per month

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Monthly payment required to achieve goal

Forecast retirement information 2) given my current program, what return do I need to achieve my goals?

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DISTRIBUTION FROM QUALIFIED PLANS REQUIRED DISTRIBUTIONS

Minimum Distribution Rules All qualified plans are required to make minimum

distributions when certain rules met Primary rule : age 70 ½

The RMD is determined by a formula Essentially divide the account balance by a life

expectancy factor Failure to Make Distributions

50% penalty of the of the amount required and not paid If should have paid $10K and only paid $4K

Penalty $3K

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DISTRIBUTION FROM QUALIFIED PLANS (Contd.) TAXATION OF KEOGH PLANS

There is no lump sum distribution after retirement Withdrawals must begin by April 1 of the year after a

person reaches 70-1/2 Ten-year forward averaging rule also applies to Keogh

plans OTHER TAX CONSIDERATIONS

Premature Distributions 10% penalty Certain exceptions

Excess Contributions 10% penalty on the excess

Insufficient Distributions 50% penalty on the shortage

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RETIREMENT INCOME: THE ULTIMATE DECISION Three principal ways to get your money

Annuity The Annuity Principle

A major concern is whether we will have enough money to last our lifetime

Insurance companies can guarantee life income payments Disposition of Proceeds

Variety of methods for payment (life income, period certain, etc)

Tax Treatment of Annuity Payments Variable Annuity or fixed annuity The Best Choice??

Lump Sum Distribution Forward Averaging Option

IRA transfer and withdrawals15

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Major Sources Of Retirement Income

Forms of Annuities

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Disposition of Annuity Proceeds

RETIREMENT INCOME: THE ULTIMATE DECISION (Contd.)LUMP SUM vs. IRA

It is a taxing decision to choose between a lump sum distribution and an IRA transfer or rollover

Best alternative depends on a host of tax-related factors

Example: John & Betty Jones, both 65, set to retire at year-end

John has the choice of $2,000 per month for life, or A lump sum of $250,000

IRA rollover with immediate withdrawals offers the best option

If John lives to age 100, the annuity option is the best19

RETIREMENT INCOME: THE ULTIMATE DECISION (Contd.)IRA DISTRIBUTION

An individual is free to choose any suitable distribution method, subject to restrictions linked to age 59-1/2 and 70-1/2

Two methods frequently used are: Systematic Withdrawal: Personal Investment Systematic Withdrawal: Insurance Plan

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RETIREMENT PLANNING STRATEGIES

This section analyzes basic strategiesused to accomplish variety of retirementplanning objectives

• LOANS FROM QUALIFIED PLANS– Taking out loan from a qualified plan may be a better

alternative than withdrawal, since no tax or penalty is imposed on a loan

– However, ultimately taxes may be imposed.• Also the plan may withdraw funds from your regular retirement

account and place them in a safer investment like a money market as collateral.

RETIREMENT PLANNING STRATEGIES (Contd.)

PLANNING FOR RETIREMENT: ADDITIONAL CONSIDERATION

Early Planning Needed Should strive to avoid penalty taxes and take advantage of

beneficial tax treatments

Minimum Distribution Rules Everyone’s RMD is calculated based upon Minimum

Distribution Incidental Benefit (MDIB) life expectancy factor table

One exception: when spouse is more than ten years younger and is sole beneficiary

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RETIREMENT PLANNING STRATEGIES (Contd.) COMBO STRATEGY

Basic Structure: Involves six steps:

1. Estimate client’s monthly budget

2. Determine client’s monthly Social Security income

3. Instruct client’s employer to transfer the lump sum directly from pension plan to an IRA with a money-market mutual fund

4. Calculate shortfall in budget

5. Set up a growth-oriented investment portfolio with desired degree of risk

6. Client should withdraw from this portfolio if and when funds are needed, subject to minimum compulsory distribution at age 70-1/2

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RETIREMENT PLANNING STRATEGIES (Contd.)

COMBO STRATEGY (Contd.) Concluding Remarks:

The Combo Strategy just described is merely one of many options available to a client.

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