RMI 2101: TOPIC 10

Retirement Risk

- retirement causes losses of income

• must plan to accumulate sufficent funds - 3 ways

•Social security - trust fund bankrupt 2035

-employer provided retirement benefits

-individual savings

- must plan for what happens when you age

-probability of illness increases possible need for long term care

-people are living longer - need funds as they age

-must plan for inflation

-future reduced purchasing power

-rising prices w/ fixed income is a problem

-heathcare goods and services very sensitive to higher inflation

introduction to social security

- Social Security enacted in 1935

- Medicare enacted in 1965

- Social Security is the largest government program in the world

- O.A.S.D.H.I

Social security

- 0.A.S.D.H.I

-must earn minimum amount in at least 40 quarters to be fully insured

-approx. - 31200 a quarter

Social security-Old Age

-retirement benefits

-amount based on earnings.

-normal retirement age Is 67 (anyone barn after 1960)

S.S. Survivors

-coverage for the survivor of a fully insured worker

-Widows / WIdowers or Surviving dworced spouse's benefits

-Child benifits

-lump-sum dealth benefits

Social security - disablity

Disability - insured is disabled

-Worker

• or dependent of worKer (spouse/child)

- definition Is strict - not as liberal as regular insurance/ee benefit disability policies.

Medicare

-part a and part B = orginal medicare

-part d = prescriptions.

-offered by the marketplace

-part c. - medicare advantage - bunaled plans usually included A, B & sometimes

Health Insurance- medicare

Part A- Hospital Benefits

Part B- Medical Benefits

Part D- Prescriptions

Part A: Hospital Benefits

- Inpatient

- Post hospital home care

- Hospice care

- Coverage free - pay a deductible (approx. $2,000)

part B: medical benefits

- Monthly premium (Approx. $105 a month)

- Covers most non-hospital expenses except....

: Routine physicals

: Routine eye, foot, and ear care

: Immunizations

: RX

: Hospital

part D: prescriptions

-effective in 2006

-particapant must enroll and pay a monthly premium and a portion of each prescription. Also must be enrolled in Part A or B to be eligible

-doughnut Hole.

Funding of Social Security

-Payroll tax on ER and EE

-actually 2 separate taxes that get rolled together.

-every & you pay in tax is also matched by Employer

-if you are self employed - you pay double

-6.2% for OASDHI up to wage base level

-$160,000 in 2023

-1.45% for HI (Medicare) is unlimited

-extra medicare tax of .9% tax on single making over $200,000 or married couple earning over 9250,000

-for most people (majority of Americans make less than $160K) the tax totals 7.65%

Funding of Social Security- example 1

-single employee makes 100K in 2023

- 6.2 % of $100k in 2023 results in taxes paid of $6200

-1.450 of $100K results in taxes paid of $1450

-$7650 In FICA

Funding of Social Security- example 2 & 3

Future Issues for Social Security

-System flawed - pay as you go as opposed to being funded - as normal insurance vehicles are - creating future funding issues

-Privatization of the system

-Would your decisions outperform the government?

Employer provided retirement plans

-defined benefit Plan - aKa Traditional Pension Plan

*(Known:)

-formula the determines benefit as retirement

-with proper information, an EL may be able to calculate benefit at retirement fairly persicely

Defined Benefit Plans

-Unknown: amount that an ER must contribute in any particular year in order to fund the promised benefit.

• Key : ER bears uncertainty and investment risk

• creates a future liability for ER.

-plan termination insurance sold by the PBGC- is required for private companies with DB plans under ERISA

Unit Formula Example

-Unit = % of salary

-EX. - for every year of serice, an ER promises 2% of final average salan at the normal retirement age.

Final average salary is the average of salery in the five years up to indluding the year of retirement vear of retirement, age 65

salary at $50 k = 65

$49k = 64

• How much benefit? = Final avg. salary = $48K

= (# of yrs of service) x (Final avg. Salary) x 2%

=(30)x(48k)x(2%)

=$28,800

Defined Contribution Plans

-EE defers a portion of their grass salary via a pre-tax payroll deduction. to the plan

-Employers can match the contributions up to a certain amount if they choose. (tho usually do)

-401k in for profit company

[403 (b)] non- profit (like Temple)

salary reduction

use pre tax dollars

Emplover Provided Retirement Plans

-Defined contribution Plans (401K /403B Is most common)

-Known: Annual ER contribution

-eg. 5% ot annual salan contributed by ER to retirement on behalt of EE

-unknown : annual retirement benefits received at retirement

defined contribution plan

-Why unknown?

-EE may also contribute

-funds are invested until retirement

-different EEs have different

Defined Contribution Plan: Key

-uncertainty regarding future retirement income, investment risk, etc rests with EE

-EE burdens the risk

-ER liability to cash contributions in the specific year

Advantages : Defined Contribution Plan

•EE's see exactly balance at all times throughout working lifetime

-EE's who change jobs several times are easily able to more account

balances to new ER's plans (in most cases)

section 401K Plans

-Known by IRS as a deferred arrangement

-the EE coniributiors are referred to in the tax code as elective defferals

-Immediate income tax deduction of EE contributions

-EE's generally have the choice of investment vehicles for their account

-EE can contribute $22,500 annually (2023)

IRA (Individual retirement accounts)

-individual retirement plan designed to supplement other types of retirement income

- Funds are invested in a variety of financial instruments and accumulate on a tax -deferred basis until distributed

-Tax deduction for IRA is limited to Individuals who do not have access to 401K plane

-can put maximum of $6500 in annually (2023)

-IRA & 401K funds

- funds cannot be withdrawn pros to age 59 1/2 except in the case of death or disability

IRA & 401K's

-10% penalty for early distribution

-taxed as ordinary income ^

-amount withdrawn after age 59 /2

-no penalty

-only taxed as ordimary income

IRA & 401K rollovers

- Occurs when you take funds out of one account and place them in another (Qualified Retirement Account)

What is allowed?

- Transfer from IRA to another IRA is allowed

- Transfer from 401k to IRA is allowed

- Transfer from one 401k into another 401k is allowed

- Cannot transfer IRA into a 401k

Roth IRA: 1997 Tax Reform Acts

-no tax deduction for contributions

-must have earned income

-interest grows tax-free

-withdraw|s are tax-free

-can contribute up to $6500 annually

pension eligibility

-ERISA - establishes minumum standards for retirement plans provided by emplovers in private industries.

-Eligibility Standards:

-minimum age cannot Exceed 21 and

- minimum service requirement cannot exceed one year

Retirement Ages

-normal retirement age (NRA)

-earliest age at which EE's can receive full benefits

early retirement age

-earliest age at which an EE may retire and receive some benefit

-typically paid a reduced benefit

Late Retirement Age

-Retirement after normal retirement age

-ER should increase benefit

-Not required to do so

Vesting

-degree a plan participant's pension rights are non-forfeitable regardless of EE continued employment with ER

-EE is always. entitled their own contributions

-vesting only applied to ER contributions

• vesting standards permitted under ERISA for DB pension Plans

vesting standards permitted under ERISA for DB pension Plans

-Five- year cliff vesting

-grade six year vesting

20%% vested after 3 yrs of service

40% vested > 4 yrs

60% vested > 5 yrs

100 % vested > 7 yrs

vesting standards permitted under ERISA 401K Plans

-three wear cliff vesting

-graded six year vesting:

20% V > 2 yrs serve

40% V > 3 yrs

60% V > 4 yrs

80% V >5 yrs

100% V > 6 yrs

vesting standards permitted under ERISA for DB pension Plans

-Five- year cliff vesting

-grade six year vesting

20%% vested after 3 yrs of service

40% vested > 4 yrs

60% vested > 5 yrs

100 % vested > 7 yrs

Vesting Example

suppose an EE has four

yrs of service and has

been particapating in her 40lK plan.

-EE has made contributions to date in the amount of $40 K

-ER has made contributions for this employee in the amount of $40k

-If EE were to leave this Ek now, how much would she be able to transter to her new ER's plan?

-EE outomatically Keep $40k

(plus)

-amount of ER contributions transferred depends on vesting schedule

under cliff vesting, all of ER's Is vested

-under grading vesting the EE could take 60% (36,000)

-ClIff = $100,000

-graded = $76,000