Chapter 18

Starting Early:
Retirement
Planning

McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
 Chapter 18
Learning Objectives
2

1. Recognize the importance of retirement planning

2. Analyze your current assets and liabilities for retirement

3. Estimate your retirement spending needs

4. Identify your retirement housing needs

5. Determine your planned retirement income

6. Develop a balanced budget based on your retirement

income
 Why Retirement Planning?
3

Objective 1: Recognize the importance of retirement

planning

Misconceptions about Retirement Planning

 My expenses will decrease when I retire

 My retirement will only last 15 years

 Social Security & my pension will pay for my basic living expenses

 My pension benefits will increase to keep pace with inflation

 My employers health insurance plan and Medicare will cover my

medical expenses
 There’s plenty of time for me to start saving for retirement

 Saving just a little bit won’t help

 Why Retirement Planning?
(continued)
4

THE IMPORTANCE OF STARTING EARLY

 To take advantage of the time value of money
 If from age 25 to 65 you invest
$300 a month (9%), at age 65 you’ll
have a nest egg of $1.4 million
 Wait ten years until age 35 to start and you’ll have about
$550,000 at age 65
 Wait twenty years until age 45 and you’ll have only
$201,000 at age 65

 See Exhibit 18-1

 Why Retirement Planning?
(continued)
5

 People are spending more years

(16-30) in retirement

 A private pension and Social Security are often

insufficient to cover the cost of living

 Inflation may diminish the purchasing power of your

retirement savings
 Why Retirement Planning?
(continued)
6

THE BASICS OF RETIREMENT PLANNING

 First analyze the current assets and liabilities, and then

estimate the spending needs and adjust for inflation

 Next evaluate the planned retirement income

 Finally increase income by working part-time if necessary

 Conducting a Financial Analysis
7

Objective 2: Analyze your current assets and liabilities

for retirement

REVIEW YOUR ASSETS

 Housing

 If owned, probably your biggest single asset

 If large equity, a reverse annuity mortgage could
provide additional retirement income
 You could sell your home, buy a less expensive one, and
invest the difference
 Conducting a Financial Analysis
(continued)
8

 Life Insurance

 Life insurance cash value can be converted into an annuity

 Other investments

 Review investments, such as stocks & bonds. Consider taking

the income from them
 Conducting a Financial Analysis
9
(continued)

Your Assets after Divorce

 Retirement assets are affected by divorce

 Pensionbenefits are considered a marital asset to be

divided, depending on the length of the marriage

 There are tax implications of the divorce settlement

 Retirement Living Expenses
10
Objective 3: Estimate your retirement spending needs

 Spending patterns, where & how you live will probably

change

 Some expenses may go down or stop, such as 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, but taxes, insurance may go up
 Federal income taxes will probably be lower
 Retirement Living Expenses
(continued)
11

 Estimate which expenses may go up:

 Life and health insurance unless your
employer continues to pay them
 Medical expenses increase with age

 Expenses for leisure activities may go up

 Gifts and contributions may increase

 See Exhibit 18-5

 Inflation will cause your expenses to increase over the course

of your probable 16-25 years in retirement
 How an “Average” Older (65+) Household
Spends its Money
12

U.S. Bureau of Labor Statistics, Consumer Expenditure Survey, Accessed June 3, 2008
13
Planning Your Retirement Housing

Objective 4: Identify your retirement housing needs

 Think about where you want to live

 Consider the cost of living, taxes & moving

 Planning Your Retirement Housing
(continued)
14

TYPE OF HOUSING

 Type of housing and changing needs

 92% prefer to stay in their own home

 A universal designed home is built to allow for potential

physical limitations
 If not built using universal design, home may need to be
retrofitted
 Continuing care retirement community provide increasing
levels of care
 Planning Your Retirement Housing
(continued)
15

AVOIDING RETIREMENT HOUSING TRAPS

 If you plan to move when you retire…

 Write the local Chamber of commerce to learn about

taxes and the economic profile
 Check on state income and sales taxes, and taxes on
pension income
 Call a local CPA to find our what taxes are rising.
 Subscribe to a local Sunday paper
 Estimate what your utility, health care, auto insurance,
food, and clothing costs would be in the area
 Rent for awhile instead of buying immediately
 Planning Your Retirement Income
16

Objective 5: Determine your planned retirement

income

Social Security
 Most widely used source of retirement
income, covering almost 97% of U.S. workers
 Meant to be part of your retirement income, but not the sole
source
 Check the Earnings & Benefit statement you receive each
year for accuracy
 Full retirement benefits at age 65 to age 67, depending on
the year you were born, but reduced benefits at age 62
 Planning Your Retirement Income
17
Social Security
 Up to 85% of your benefit may be subject to federal income
tax for any year in which your AGI plus your nontaxable
interest income & one-half of your Social Security benefits
exceed a base amount. Publication 554
 Social Security payments are reduced if you earn above a
certain income
 Cost of living adjustment each year
 Spouse's benefit is one-half of the worker’s benefit
 See www.ssa.gov
 Planning Your Retirement Income
18

FUTURE OF SOCIAL SECURITY

 Many people are concerned about the future of Social
Security. Bush plan to overhaul it
 Longer life expectancies means retirees collect benefits
longer
 People are retiring earlier and entering the system sooner
and staying longer
 The baby boomers will begin retiring soon and the ratio of
workers to retirees is doing down
 In 1945 there were 42 workers per retiree,
 In 2008 there are three workers per retiree, by 2032 it
will drop to 2.1 workers per retiree
 Planning Your Retirement Income
19

OTHER PUBLIC PENSION PLANS

 The Veterans Administration provides pension for many
survivors of men and women who died while in the armed
forces, and disability pensions for eligible veterans
 The Railroad Retirement System
 Planning Your Retirement Income
20
Employer Pension Plans - Defined Contribution

Individual accounts for each employee



 Money-purchase pension plans - A percent of your earnings

are set aside, along with any employer contributions
 Stock bonus plans - Employer’s contribution is used to buy
stock in your company for you
 Profit-sharing plans - Employer’s contribution depends on
the company’s profits
 Planning Your Retirement Income
21
Employer Pension Plans - Defined Contribution

 Salary reduction or 401(k), 403(b) or 457 plans

 Employer makes non-taxable contributions and reduces
your salary by the same amount
 Employee contributions are tax-deferred
 Some employers match a portion of the funds you
contribute
 See Exhibit 18-9
 See Exhibit 18-10 for comparison between defined
contribution and defined benefit plans
 Planning Your Retirement Income
22
Employer Pension Plans - Defined Benefit

Employer will pay you a certain amount per month

when you retire based on your pre-retirement salary
and number of years of service
Employer makes the investment decisions for your
and their contribution, but your benefit amount stays
the same regardless of how the investments perform
 Planning Your Retirement Income
23
 Plan Portability: You can carry earned benefits from
one employer’s pension plan to another’s when you
change jobs
 Vesting is your right to at least a portion of the
benefits you have accrued under an employer pension
plan, even if you leave before you retire
 When you leave a job you can cash in your pension
(tax consequences), have the employer keep the funds
so you will get a future pension from them, rollover the
funds into an IRA, or transfer the funds to invest in a
pension with your new employer if your pension is
portable
 Anticipated Sources of
24
Retirement Income

Employee Benefit Research Institute, May 2005

 Living on Your Retirement Income
Objective 6: Develop a balanced budget based on your assessment
25 income
 Make sure you receive all retirement income to which you are
entitled
 Develop a spending plan for retirement
 If you have the skills and ability, do some things
yourself that you used to hire others to do
Tax Advantages
 Take advantage of all tax savings retirees
 Retirees get a variety of tax savings
Investing for Retirement
 Monitor your investments
 Invest some of your retirement income for growth, to allow for
inflation and increased health care costs
Dipping into Your Nest Egg
 Dip into savings with caution, since you do not know how long
you will live
 MALAYSIAN SITUATION
26

 In Malaysia, the Employee Provident Fund (EPF) -

source of income for retirement for the private
sector employees.
• Although EPF savings is one of the main channels to
provide for retirement, 99.9% of the contributors
would withdraw their EPF savings in one lump sum
once they reach 55 years of age and 70% of them
would use up all their EPF savings in just three years
post-retirement
• (Great Eastern Life Assurance (M) Bhd executive vice-president and chief
marketing officer Loke Kah Men)
 Unexpected
expenses without
proper emergency
Spend first, save fund – leads to
later withdrawing savings
for other purposes or
using credit card to
incur more liabilities

COMMON ISSUES OR
PROBLEM
Tendency to use
retirement savings Broken marriage life
for other purposes

Changing
employment
frequently
CALCULATING RETIREMENT FUNDS
 Eg. Amount needed is RM50,000 per annum for 20
years after retirement. Rate of return 8%, inflation
4%
 Adjusted rate of return = (1.08/1.04)-1) x 100

= 3.8462%
n = 20
I = 3.8462
PMT = -50000
PV = 715360
NEEDS ANALYSIS OF RETIREMENT
Projecting income during retirement largely depends on
how much capital is available upon retirement

Scenario: Zahid, aged 55, has just retired and has

RM1,000,000 in his bank account after liquidating all
his equity investments and emptying his EPF account. Life
expectancy is 70. Zahid wants to put his savings in
Merdeka Bond that pays 5% annually. How much is his
annual income if he choose:
(1) To leave his capital intact?
(2) To spend all his capital during retirement period?
 NEEDS ANALYSIS OF RETIREMENT
How much is his annual income if he choose:
(1) To leave his capital intact?
i%= 5
PV= 1,000,000
Income = i% * PV = 50,000

(2) To spend all his capital during retirement period?

n = 15
i% = 5
PV = 1,000,000
Income = PMT (solve) = 96,342
 His target retirement fund is RM828,000 before reaching age 55.
He only has 20 years to save. Based on an Investment Return of 6% per annum,
he needs to save RM 22,600 per annum or RM 1,883 per month.

Below is an illustration to show that if Mr A started saving when he was 20

years old,
the amount he had to save monthly was only RM625,
which may be much more affordable!

START AGE Target at age 55 Monthly Saving

(RM) (RM)
20 828,000 625
25 828,000 875
30 828,000 1258
35 828,000 1883
40 828,000 2958
45 828,000 5241
50 828,000 12250
 Select a
target
date.

Talk with Estimate

your Tips money
you need
banker or manage to
tax RP accumulat
advisor. e.

Find out
about your
Social
Security
benefits.
 Don't
touch your
savings.

Calculate Diversify
the your
estimated. assets.

Investing
money Seek the
shouldn't profession
stop when al financial
retirement advisor.
begins.
set clear
ST and LT
goals.