Retirement

Planning

Retirement Plan Sponsors

1. U.S. government
2. Employer-sponsored plans
3. Individual retirement
accounts
4. 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
$1,200
$1,000

909

947

1,044
1,0271,044
979 1,002
844

$800
Average Monthly Benefit

$600

720
603

$400
$200
$0
1990

Current dollars

1995

2000

Constant (2006) dollars

2005

2006

Employer-Sponsored Retirement
Plans
Defined Benefit and Defined Contribution Plans in
the U.S.
1990 to 2005
800
700
600
500
Defined-contribution
plans
400

Number of Plans (Thousands)

Defined-benefit 300
plans
200
100
0
1990

1995

2000

2005

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 Plans

Key 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 Benefit

Retirement Income
A typical retirement benefit is based
on three factors:
1.A multiplier (typically around 2.0)
2. Retirees average pay (typically the
average of the employees 3 to 5 years
highest pay))
3.Total years employed

Example Defined Benefit Plan Terms

Vesting Schedule:
Years
Employed
Percent Vested
2

20%

40%

60%

80%

100%

Employee Contributions:
None

Retirement Benefit Formula:

Annual retirement benefit =
M x Years x Average Salary
where:

M = a multiplier such as 2.2

Years = years of employment
with the employer
Average Salary = avg annual
salary 5 highest paid years

Retirement Age and Benefits:

100% of benefit at age 65 with a minimum
of 10 years employment
100% of benefit at any age with 35 years
of employment
If less than age 66 and
age + years of employment >= 75
100% of benefit less 5% of benefit for
each year less than 65

Defined Benefit Plan

Example Benefit Calculation
Laura will have been working for Amalgamated
Industries for 22 years at the end of this year
when she plans to retire.
Amalgamateds retirement plan pays an
annual benefit of 2.1% times the employees
average 5 years highest pay times the years of
service. Lauras last five years were her highest
paid ones during which her average pay was
$84,000.
Compute Lauras monthly retirement income.
Annual retirement income = .021 x 84,000 x 22
= 38,808
Monthly 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

Benefits of Defined Contribution

Plans
Tax break
Flexible investment options

Types of Defined Contribution Plans

401(k)
403(b)
SEP
SIMPLE IRA
Profit-sharing plan
ESOP

Leaving a Job Before Retirement

What 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 59

Retirement Accounts for SelfEmployed Individuals

Keogh plan
SEP

Financial Life Cycle

1.
2.
3.
4.
5.

Education
Employment
Approaching retirement
Retirement
Estate planning

Start Saving for Retirement

Early
Monthly Savings Needed to have $1,000,000 by Age 60
$2,413

$2,500

$2,000

Monthly Savings Needed

$1,500

$1,317

$1,000

$754

$442

$500

$263
$158

$0
20

25

30

35

Age When Starting to Save

40

45

Life Cycle Investing

Phase

Savings
(Investment)
Targets

Investment
Horizon

Risk
Taking
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 allocation
2. Invest in life cycle mutual funds
a) Target-date life cycle funds
b) Target-risk life cycle funds

Estimating Retirement Fund

Values
1. Constantly monitor account
balances
2. Perform scenario analyses