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Flashcards in Retirement Deck (242)
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1

Wage Replacement Ratio

(top-down approach)

  • Subtract payroll tax (7.65%)
  • Subtract savings amount

2

Wage replacement ratio

(bottom up approach)

  • Budget for actual needs.

3

Capital Preservation Model

  • Preserve capital at the beginning of retirement to have the same amount at death.
  • N = Number of years of retirement
  • i = interest rate
  • FV = amount needed at death (from previously calculated amount needed at retirement)
  • PMT = 0
  • PV = ? Amount needed at retirement to create FV at death.
  • Add FV (amount needed at retirement for life needs) + PV (amount needed at retirement to leave that amount)

4

Purchasing power preservation model

  • Amount needed at death = inflation-adjusted amount necessary at retirement.
  • Capital preservation model adjusted for inflation.
    • N = number of years of retirement
    • i = inflation adjusted rate ((1 + interest rate)/(1 + inflation rate) - 1) * 100
    • PV = ? amount needed at death/retirement
    • PMT = amount needed at first year of retirement.
    • FV = amount needed at retirement without capital preservation.
  • OR use: inflation-adjusted rate with the capital preservation model instead of regular interest rate.

5

Sensitivity Analysis

  • Changes the variables toward increased risk.

6

Qualified Plan Compensation Limit

  • $265,000

7

Work life expectancy

  • Period during which one earns, saves and accumulates for retirement.

8

Retirement life expectancy

  • How long someone will be retired until death.

9

Annuity Method of Capital Needs Analysis

  1. Determine WRR
  2. Determine gross dollar needs in today's dollars.
  3. Reduce by expected SS
  4. Inflate dollar needs by inflation rate (or CPI) - BEGIN MODE
  • N = remaining work life
  • i = inflation rate
  • PV = retirement needs in today's dollars
  • PMT = 0
  • FV = ?
  1. Determine present value at retirement:
  • N= years of retirement
  • i = inflation adjusted rate )(1 + interest/1 + inflation) - 1)) * 100
  • PV = ? Amount needed at retirement
  • PMT = FV from last step (inflated need)
  • FV = 0

10

Monte Carlo Analysis

  • Randomized generator of variable outcomes.

11

Calculate retirement needs

  • BEGIN MODE
  • Use cash flow to determine NPV of necessary amount adjusted for inflation
  • Inflate that amount by interest rate to determine future value of that amount at retirement.
  • N = number of years to retirement
  • i = interest rate (not inflation-adjusted
  • PV = NPV from last step
  • PMT = 0
  • FV = ?

12

Types of Pension Plans

  • Defined contribution plans: money purchase pension plans, target balance pension plans.
  • Defined benefits plans: defined benefit pension plan, cash balance pension plan.

13

Profit sharing plan

  • All defined contribution plans
    • Stock bonus plans
    • ESOPs
    • 401Ks
    • Thrift Plans - after-tax
    • Age-based profit sharing plans
    • New comparability plans

14

Defined benefit pension plans

  • Defined benefit pension plan and cash balance pension plans
  • annual contribution limit is not less than the current liability to pay out benefit (actuary determines) - amount contributed depends on investment performance, etc.
  • Employer assumes investment risk
  • Subject to Pension Benefit Guaranty Corp. (insurance with caps)
  • forfeitures cover plan costs
  • no separate accounts
  • credit can be given for prior service from prior to plan set up.

15

Defined contribution pension  plans

  • Money purchase pension plans
  • Target benefit pension plans
  • Contribution amount is defined in plan document.

16

Pension plan

  • pays pension at retirement - legal promise
  • no in-service withdrawals (can take lump sum if leave company and can take partial if 62 or over)
  • mandatory funding
  • 10% can be invested in employer securities (if defined contribution plan, participants can diversify investments)
  • Qualified Joint Survivor Annuity & Qualified Pre-retirment Survivor Annuity - surviving spouse gets paid

17

Profit sharing plan characteristics

  • Deferral of compensation 
  • in-service withdrawals allowed after 2 years
  • no mandatory funding for employer- funding only has to be substantial and recurring.
  • use a predetermined formula for funding, but it is not a fixed amount 
  • can fund from 0 - 25%
  • must be nondiscriminatory or meet a mathematical formula that allows discrimination
  • can invest up to 100% in employer securities
  • can be contributory or noncontributory (by employee)
  • no Q joint survivor Annuity or QPSA

18

Defined Contribution Plan

  • includes all profit-sharing plans and
  • includes money purchase plan and target benefit pension plans
  • employer's annual contribution limit is up to 25% of covered compensation
  • employee assumes investment risk - controlled by employee
  • forfeitures (unvested money) are allocated to employees or offset plan costs
  • not subject to Pension Benefit Guaranty Corp. benefit
  • Separate investment accounts
  • no credit for prior service.

19

Qualified plan advantages

  • income tax deferred
  • payroll taxes avoided for employer contributions
  • ERISA creditor protection (protected from bankruptcy)
  • Special tax treatment for lump sum distributions

20

Qualification requirements for qualified plans

  • must have plan document
  • must have eligibility requirements
  • must have coverage requirements
  • vesting requirements
  • special qualification requirements when plans get top-heavy (key employees)
  • there are limitations on benefits and contributions 

21

Plan document

  • terms of the plans
  • must be consistent with IRC qualification requirements
  • must be in writing and signed for plan year

22

Qualfied plan eligibility

  • employees who are 21 and over and have 1 year of service (1,000 hours in one plan year) must be eligible
    • special election to require 2 years of service, but 100% vesting is required immediately (not available to 401K's)

    • tax-exempt educational institutions can require 26 years old

  • plan must have at least 2 entrance dates per year. (can't make ppl wait more than 6 months)

23

Qualified plan coverage can exclude

  • can exclude
    • ineligible employees
    • unionized employees
    • nonresident alien employees who do not perform services in the US

24

Qualified plan coverage discrimination tests

  • plans must be nondiscriminatory
  • must meet 1 test:
    • Safe harbor test:
      • must cover at least 70% of non highly compensated employees
    • Ratio % test: 
      • % of NHC covered/% of HC covered is at least 70%
    • Average benefits test:
      • avg. benefits of NHC covered/ avg. benefits of HC covered is at least 70%

25

Defined benefit plan add'l coverage requirement

  • In addition to 70% test, DB plan must pass:
  • 50/40 test: people first, % second
    • plan must cover the lesser of:
      • 50 non-excludable employees
      • 40% of non-excludable employees

26

Highly compensated employee

  • owner-employees: who own at least 5% of company this year or last year and attributed shares to his/her family (even if not actively involved)
  • owner or non-owner employees with salaries over $120K last year and,
  • if elected, in top 20% of employees ranked by salary. "20% election" (instead of 120K - owners always included)
    • ineligible or noncovered employees not included in this 

27

Vesting Defined Contribution Plan

  • 2-6 year graduation (starts in year 2)
  • 3 year cliff (100% vested after 3 years of service)

28

Vesting Defined Benefit Plan

  • 3-7 year graduated (begins in year 3)
  • 5 year cliff (0% vested until 5 years, then 100% vested)

29

Top heavy definition

  • Defined Benefit plan - present value of accrued benefits of key employees exceeds 60% of accrued benefits for others.
  • Defined contribution plan - aggregate account balances of key employees exceeds 60% of aggregate accounts of all

30

Key employee

  • greater than 5% owners
  • greater than 1% owner with salary of 150K or more
  • officer with compensation in excess of 170K
  • a key is top heavy - have the keys to executive bathroom.