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Retirement Plan Sponsors
1. U.S. government2. Employer-sponsored plans3. Individual retirement accounts4. Self-employed retirement accounts
Social Security
• Old-Age, Survivors, and Disability Insurance (OASDI) - Provides income to:– Covered individuals over age 65-67 (age 62 for
reduced benefits)– Surviving children or spouses of covered
individuals– Disability income to covered individuals and family
members
Average Monthly Social Security Retirement Benefit for an Individual
1990 1995 2000 2005 2006$0
$200
$400
$600
$800
$1,000
$1,200
603
720
844
1,0021,044
909947
9791,027 1,044
Current dollars Constant (2006) dollars
Ave
rage
Mon
thly
Ben
efit
Employer-Sponsored Retirement PlansDefined Benefit and Defined Contribution Plans in the U.S.
1990 to 2005
1990 1995 2000 20050
100
200
300
400
500
600
700
800
Num
ber o
f Pla
ns (T
hous
ands
)
Defined-benefit plans
Defined-contribution plans
Defined Benefit Plans
• Also called pension plans
• Promise a certain income on retirement
• Retirement income usually based on a multiple of last 3-5 years pay
• Employer responsible for investment risk
Defined Benefit PlansKey Items You Should Know About Your Plan
• Length of service needed until becoming vested in the plan
• Amount of contributions required by the employee
• How to compute the retirement benefit
• At what age can employee begin receiving benefits
Computing Defined BenefitRetirement Income
A typical retirement benefit is based on three factors:1.A multiplier (typically around 2.0)
2. Retiree’s average pay (typically the average of the employee’s 3 to 5 years highest pay))
3.Total years employed
Example Defined Benefit Plan Terms
Retirement Benefit Formula:Annual retirement benefit = M x Years x Average Salarywhere: M = a multiplier such as 2.2
Years = years of employment with the employerAverage Salary = avg annual salary 5 highest paid years
Retirement Age and Benefits:100% of benefit at age 65 with a minimum of 10 years employment100% of benefit at any age with 35 years of employmentIf less than age 66 and age + years of employment >= 75 100% of benefit less 5% of benefit for each year less than 65
Vesting Schedule:Years
Employed Percent Vested2 20%3 40%4 60%5 80%6 100%
Employee Contributions:None
Defined Benefit PlanExample Benefit Calculation
Laura will have been working for Amalgamated Industries for 22 years at the end of this year when she plans to retire.
Amalgamated’s retirement plan pays an annual benefit of 2.1% times the employee’s average 5 years highest pay times the years of service. Laura’s last five years were her highest paid ones during which her average pay was $84,000.
Compute Laura’s monthly retirement income.
Annual retirement income = .021 x 84,000 x 22 = 38,808Monthly retirement income = 38,808/12 = 3,234
Defined Contribution Plans
• Employer and/or employee contribute to a retirement account
• Retirement benefit depends on the value of the account on retirement
• Beneficiaries, not employers, assume the investment risk of the account
Leaving a Job Before RetirementWhat Happens to Your Retirement Account?
1. Leave funds in the plan and draw benefits when you reach retirement age for the plan
2. Withdraw vested funds from plan and place them in another qualified plan
3. Transfer the plan to your new employer
Individual Retirement Accounts
• Traditional IRA– Contributions are tax deductible– Benefits are taxable
• Roth IRA– Contributions are not tax deductible– Benefits are tax-free
• Both plans allow account holder to begin withdrawing funds at age 59½
Financial Life Cycle
1. Education2. Employment3. Approaching retirement4. Retirement5. Estate planning
Start Saving for Retirement Early
20 25 30 35 40 45
$0
$500
$1,000
$1,500
$2,000
$2,500
$158$263
$442
$754
$1,317
$2,413
Monthly Savings Needed to have $1,000,000 by Age 60
Age When Starting to Save
Mo
nth
ly S
av
ing
s N
ee
de
d
Life Cycle Investing
Phase
Savings (Investment) Targets
Investment Horizon
RiskTaking Ability
Education Spend on education
Very long term High risk
Employment Save as much a possible
Very long term to long term
High risk
Approaching retirement
Continue saving
Intermediate term Balanced risk
Retirement Withdraw savings
Short term Low risk
Estate planning Bequests of savings
Short term Low risk
Implementing Life Cycle Investing
1. Select your own asset allocation2. Invest in life cycle mutual funds
a) Target-date life cycle fundsb) Target-risk life cycle funds