1

Chap 16 – Retirement Planning

Objectives:

– Review of need to save for retirement

– Understand types of plans and how they differ• Defined benefit and defined contribution• Tax aspects – 401(k) versus Roth IRA

2

Social Security

• Paid for by equal taxes on employer and employee, currently 7.65% for each– Social Security – 6.2% and Medicare - 1.45%

• Provide base level of protection– not intended to maintain current life style

• Current tax payments pay current benefits • Benefits based on years worked, past

earnings and future inflation

3

Employer-Funded Benefits

• Defined Benefit Plans – fixed payment beginning at retirement

• Based on formula including average salary in final period (usually last five years) times years of service times a “factor”

• Example: Final average salary = $70,000, 25 years service, 1.5% factor:– Benefit = 70,000 * 25 * .015 = $26,250/ year

4

Defined Benefits

• Employer takes all investment risk – promises a fixed monthly payment

• No inflation adjustment; not portable

• Only defined benefit plans insured by the Government, not defined contribution plans

• Employees may contribute to increase benefits

5

Tax Issues

• Tax-favored plans: defined contribution plans, 401 (k), IRA, and more

• Allows investment earnings to grow untaxed until distributed; penalty if withdrawn before 59 ½.

6

401 (k) Plans

• Type of employer-sponsored DC plan– Employer and employee contribute or just

employee

• Contributions not included in taxable income and not taxed until withdrawn– $12,000 maximum employee contribution– Employer may contribute up to 15% of salary

7

Traditional IRA’s

• Individual Retirement Account

• May contribute up to $3,000/year

• May or may not be tax deductible– Depends on income level and whether self or

spouse covered by company retirement plan

• May roll over assets from another retirement plan on a tax free basis.

8

Roth IRA’s

• Contributions – not tax deductible

• Once money contributed, grows tax free and not taxed on withdrawal– Must have been established for five years to

withdraw without penalty

9

Retirement Plan Concerns

• Under saving • Demographics • Stock Market • Company match

• DB continuation?• Social Security • PBGC • Changing attitudes