Chapter 14
Starting Early:
Retirement and
Estate Planning
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Retirement Planning
Chapter Learning Objectives
LO14.1
LO14.2
LO14.3
LO14.4
Analyze your current assets and liabilities
for retirement and estimate your retirement
living costs.
Determine your planned retirement
income and develop a balanced budget
based on your retirement income.
Analyze the personal and legal aspects
of estate planning.
Distinguish among various types of
wills and trusts.
14-2
Learning Objective LO14.1
Analyze Your Current Assets and Liabilities for
Retirement and Estimate Your Retirement Living
Costs
Misconceptions About Retirement Planning
•
•
•
•
•
You have plenty of time to start saving for retirement …
Saving just a little bit won’t help …
You’ll spend less money when you retire …
My retirement will only last 15 years …
You can depend on Social Security and a company
pension to pay your basic living expenses …
• Your pension benefits will increase to keep pace with
inflation …
• Your employer’s health insurance plan and Medicare will
cover all your medical expenses when you retire…
14-3
The Importance of Starting Early
Take advantage of the time value of money
– Start at age 25:
• Invest $127 a month
• At 11% APR
• For 40 years
– Start at age 50:
• Invest $ 2,244 per month
• At 11% APR
• For 15 years
N
= 480 months
I/Y = 0.9167 = 11%/12
PMT
= -127
PV
=0
FV CPT = $1,092,216
N
= 180 = 15 yrs x 12
I/Y
= 0.9167
PMT CPT = - $2,244
PV
=0
FV
= $1,020,362
14-4
Conducting a Financial Analysis
Assets - Liabilities = Net Worth
– Ideally net worth should increase each year
Housing
– If owned, probably your biggest single
asset
– If large equity, a reverse mortgage could
provide additional retirement income
– Sell your home, buy a less expensive one,
and invest the difference
14-5
Conducting a Financial Analysis
Life Insurance
– May reduce coverage as you near
retirement and children are self-sufficient
– Increase income by lowering premiums
Other Investments
– After retirement, consider changing your
objective from growth to income
14-6
Estimating Retirement Living
Expenses
• Spending patterns and where and how you
live will probably change
• Some expenses may go down or stop:
401(k) retirement fund contributions
Work expenses - less for gas, lunches out
Clothing expenses - fewer and more casual
Housing expenses - house payment may
stop if your house is paid off
Federal income taxes
will probably be lower
14-7
Estimating Retirement Living
Expenses
• Other expenses may go up
Life and health insurance unless your
employer continues coverage
Medical expenses increase with age
Expenses for leisure activities
Gifts and contributions
• Inflation will increase amount needed
to cover expenses over the course of
retirement
14-8
How an “Average” Older (65+)
Household Spends its Money
Source: U.S. Bureau of Labor Statistics
14-9
Learning Objective LO14.2
Determine Your Planned Retirement Income and
Develop a Balanced Budget Based on Your
Retirement Income
Major Sources of Retirement Income
Employer Pension Plans
Public Pension Plans
Personal Retirement Plans
Annuities
14-10
Employer Pension Plans
Defined Contribution
An individual account to which the employer
contributes a specific amount annually
– Money-purchase pension plans
• % of earnings set aside annually, along with any
employer contributions
– Stock bonus plans
• Employer’s contribution buys stock in your
company for you
– Profit-sharing plans
• Employer’s contribution depends on the
company’s profits
14-11
Employer Pension Plans
Defined Contribution
401(k) plan
• Salary-reduction plan
• Employer makes non-taxable contributions
and reduces your salary by the same amount
• Employee contributions are tax-deferred
• Some employers match a portion of your
contribution
• Funds invested in stocks, bonds, & mutual
funds
• Vesting period
14-12
Employer Pension Plans
Defined Benefit
•
Employer will pay you a certain amount per
month when you retire based on:
– Pre-retirement salary
– Number of years of service
•
Employers make the investment decisions
for your contribution and theirs
• Your benefit amount stays the same
regardless of how the investments perform
14-13
Employer Pension Plans
Portability of Plans
– Allows you to carry earned benefits from
one employer’s pension plan to another
when you change jobs
ERISA
– Employee Retirement Income Security Act of
1974
– Sets minimum standards for pension plans
– Federal government insures part of the
payments promised by defined-payment
plans
14-14
Public Pension Plans
Social Security
• Most widely used source of retirement
income, covering 97% of U.S. workers
• Meant as part of your retirement income,
not the sole source
• Check the Earnings & Benefit statement
you receive each year for accuracy
• See www.ssa.gov
14-15
Public Pension Plans
Social Security Eligibility
• Full retirement benefits at age 65 to 67
– Depends on year of birth
– Reduced benefits at age 62
– Full retirement age being increased in
gradual steps
• Benefits based on earnings over the years
– Must earn a certain number of credits to qualify
• Certain dependents may receive benefits
14-16
Personal Retirement Accounts
Individual Retirement Accounts (IRA)
• Regular (traditional) IRA
– Allows $5,000 contribution in 2012 and beyond
• $6,000 if over 50
– Contribution may be tax-deductible, depending on
your tax filing status and income
– Interest accumulates tax free until you begin
withdrawal
– May begin withdrawing at 59 ½
– Must begin withdrawing at 70 ½
– Withdrawals are taxable income
14-17
Individual Retirement Accounts
• Roth IRA
– Contributions are not tax deductible
– Distributions tax free after age 59 ½
– Same contribution limits as traditional IRA
• If you are single with an AGI < $120,000
• or If you are filing jointly with an AGI < $176,000
• Can continue to contribute even after age 70 ½
– After five years, withdrawals are tax free and penalty
free, if:
• You are at least 59 ½ … or
• Funds used as a down payment on a first-time home
purchase
14-18
Individual Retirement Accounts
• Simplified Employee Pension (SEP)
– IRA funded by the employer
– Employer can make annual contributions up to
$50,000
– Employee’s contributions fully tax deductible
– Simplest retirement plan for the self-employed
• Spousal IRA
– Contributions for a nonworking spouse if filing a joint
return
– Contribution limits same as for Roth or Traditional
IRAs
14-19
Individual Retirement Accounts
• Rollover IRA
– Traditional IRA allowing transfer of all, or a
portion, of your taxable distribution from a
retirement plan or other IRA
• Education IRA
– Coverdell Education Savings Account
– May give up to $2,000 a year to each
child under age 18
– Contributions not tax-deductible
– Tax-free distributions for education expenses
14-20
Individual Retirement Accounts
• Keogh Plans
–
–
–
–
H.R. 10 plan or self-employed retirement plan
Designed for the self-employed
Annual tax-deductible contributions limited
Can be difficult to administer
• Limits on Personal Plans
– Cannot leave money in a tax-deferred retirement plan
forever (except for Roth IRA)
– At retirement or by age 70½ you must begin to
receive a minimum lifetime distribution
14-21
Types of IRAs
14-22
Annuities
• Provides guaranteed income for life
– Purchase with proceeds of an IRA or company pension
– Use as supplemental retirement income
– Single or periodic payments
• Interest accumulates tax free until payments
begin; distributions taxed as ordinary income
• Immediate annuity = payments begin right away
• Deferred annuity = payments begin at some
future date
14-23
Anticipated Sources of
Retirement Income
Social Security Administration
14-24
Living on Your Retirement Income
• Estimate a retirement budget
• If funds are not enough:
– First, make sure you are getting all the income
–
–
–
–
you are entitled to
Convert assets into cash or sources of income
Consider the trade-off between spending and
saving
Consider working during retirement
Dip into your nest egg cautiously and consider
what you would like to leave for your heirs
14-25
Learning Objective LO14.3
Estate Planning
• Your estate = everything you own
• Estate planning = a detailed plan for the
administration and disposition of your property
during your lifetime and at your death
– While you work you accumulate funds for your future
and for your dependents.
– As you grow older, your emphasis will shift from
accumulating assets to distributing them wisely
14-26
Estate Planning Phases
1. Build estate through savings, investment,
and insurance
2. Ensure that your estate is distributed as
you wish after your death
– If married: consider needs of spouses
– If single: financial affairs in order for
beneficiaries
– Make sure important documents are
accessible, understandable, and legally proper
14-27
Legal Documents
•
•
•
•
•
•
•
•
•
•
Birth, marriage, and divorce documents
Legal name changes
Military service records
Social Security documents
Veteran’s documents
Insurance policies
Transfer records of joint bank accounts
Safe-deposit box records
Automobile registration
Titles to stock and bond certificates
14-28
Learning Objective LO14.4
Types of Wills and Trusts
Wills
• The legal declaration of a person’s mind as to
the disposition of his or her property after death
• Have an attorney draft your will to avoid
difficulties
• A standard will can cost between $300-$400
14-29
Types of Wills
1. Simple or “I love you” will
 Leaves everything to your spouse
 Sufficient for small estates
2. Traditional marital share will
 Leaves 1/2 to spouse, 1/2 to children
of your issue or heirs
 May be held in a trust
 Trust = arrangement by which a
designated person manages
assets for the benefit of someone
else
14-30
Types of Wills
3. Exemption trust will
 Passes to your spouse except for an
amount equal to the exemption, which
passes into a trust
 Trust can provide a lifelong income
4. Stated amount will
 Allows you to pass along to your spouse
any amount that satisfies the family’s
financial needs
14-31
Intestate and Probate
• Intestate
– You die without a will
– The state distributes your assets
– May mean the state will decide on a
guardian for your children
– Very complicated if a “blended” family
• Probate
– Probate court generally validates wills and
makes sure your debts are paid
– Expensive, lengthy, and public
14-32
Will Formats
• Holographic will
– Will that you write, date and
sign, entirely in your handwriting
– May not be recognized in some states
• Formal will
– Usually prepared with attorney’s assistance
– You must sign and have two witnesses,
neither of whom can be beneficiaries
– Beneficiary = person you have named to
receive property
14-33
Will Formats
• Statutory will
– A type of formal will on a preprinted form
– Available from a lawyer or stationery store
– May include provisions which are not in
the best interest of your heirs
14-34
Writing Your Will
Selecting an Executor
Executor: one who is willing and able to execute
the provisions of your will.
Tasks may include:
• Preparing an inventory of your assets
• Collecting any money due and paying off debts
• Filing all income and estate tax returns
• Making decisions about investing or selling
assets to pay off debts or provide income
• Distributing the estate and making a financial
accounting to your beneficiaries
14-35
Writing Your Will
Selecting a Guardian
• A guardian assumes the responsibility
for providing the children with personal
care and managing the estate for them
• Don’t forget any pets in the home!
– They need a guardian, too
14-36
Altering or Rewriting Your Will
• Reasons to review your will:
– You move to a new state with different laws
– You have sold property mentioned in the will
– The size and composition of your estate has
changed
– You have married, divorced
or remarried
– Potential heirs born or died
• Adding a codicil
– Document that explains, adds or deletes
provisions in your existing will
14-37
Living Will
• Living Will
– Allows you to specify whether
or not to be kept on artificial
life support
• “Do Not Resuscitate” (DNR)
– May also appoint someone to
make health care decisions on
your behalf in case you are
unable to do so
14-38
Power of Attorney
• Power of Attorney
– Legal document authorizing someone to
legally act on your behalf if you become
seriously ill or injured
• Health Care Power of Attorney
– Combines a living will and
power of attorney for use
in making health related
decisions
14-39
Letter of Last Instruction
• Not legally binding
• Provides heirs with information
• Could include:
– Funeral preferences
– Names of people to be notified of your
death
– Location of bank accounts and safe
deposit box
– Assets and debts
– Social Security number
– Disposition of personal effects
14-40
Trusts
• Legal arrangement through which a
trustee holds your assets for your benefit
or that of your beneficiaries
– Trustee may be an individual or an institution
• Benefits of Trusts:
– Reduce estate taxes
– Avoid probate; transfer assets immediately
– Free you from managing assets
– Provide income for a surviving spouse
– Ensures property serves desired purpose
after your death
14-41
Types of Trusts
• Revocable trust
– You retain the right to end the trust or
change its terms during your lifetime
– May avoid the lengthy probate process
– Does not provide shelter from federal or
state estate taxes
• Irrevocable trust
– You cannot change the terms once
instituted
– Used to reduce estate taxes
– Avoids probate
14-42
Types of Trusts
• Credit-shelter trust
– “Bypass trust”
– “Residuary trust”
– “A/B trust”
– “Exemption equivalent trust”
– “Family trust”
– Enables surviving spouse to avoid federal
taxes on a certain amount of assets
14-43
Types of Trusts
• Disclaimer trust
– For couples without enough assets to
warrant a credit-shelter trust but may in the
future
– Surviving spouse receives everything but
may “disclaim” or deny some assets
• Anything disclaimed goes into a credit-shelter
trust
– Protects wealth from estate taxes
14-44
Types of Trusts
• Living trust
– “Inter vivos trust”; in effect while you are alive
– Property management arrangement
– Advantages:
•
•
•
•
•
Insures privacy; Assets in trust avoid probate
Allows review of trustee performance
Relieves you of management responsibilities
Less likely to create arguments among heirs
Can guide family and doctors if you are unable to
make decisions
• Testamentary trust
– Established by your will
14-45
Taxes And Estate Planning
• Estate taxes
– Federal tax on value of property at death
– Tax on fair market value
– $5.12 million exempt in 2012
• Estate and Trust Federal Income taxes
– Estates and certain trusts must file tax
returns
– Trusts and estates must pay quarterly
estimated taxes
14-46
Taxes And Estate Planning
• Inheritance taxes
– Tax on property left by a person in his/her
will
– Imposed by states
– 4 to 10% on average
• Gift taxes
– Tax on gifts >$13,000 given by one person to
another in a single year
– Imposed by both state and federal
governments
14-47
Chapter Summary
Learning Objective LO14.1
• Net worth = Assets - Liabilities
• Review your assets to ensure they are
sufficient for retirement.
• Estimate your living expenses.
– Some expenses are likely to decrease
while others will increase.
14-48
Chapter Summary
Learning Objective LO14.2
• Possible sources of income during
retirement include:
–
–
–
–
Employer pension plans
Public pension plans
Personal retirement plans
Annuities
• If your income approximates your expenses,
you are in good shape; if not, determine
additional income needs and sources.
14-49
Chapter Summary
Learning Objective LO14.3
• The personal aspects of estate planning
depend on whether you are single or
married.
• Never having been married does not
eliminate the need to organize your financial
affairs.
• Every adult should have a written will.
• A will is a way to transfer your property
according to your wishes after you die.
14-50
Chapter Summary
Learning Objective LO14.4
• The four basic types of wills are:
– Simple will
– Traditional marital share will
– Exemption trust will
– Stated amount will
• Types of trusts include:
– Credit-shelter trust
– Disclaimer trust
– Living trust
– Testamentary trust
• Federal and state governments impose various
types of estate taxes
14-51