Personal Finance: Retirement Planning

This article is written like an advertisement. Please help rewrite this article from a neutral point of view. For blatant advertising that would require a fundamental rewrite to become encyclopedic, use {{db-spam}} to mark for speedy deletion. (December 2007)

This article does not cite any references or sources. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. (March 2007)

Retirement planning, in a financial context, refers to the allocation of finances for retirement. This normally means the setting aside of money or other assets to obtain a steady income at retirement. The goal of retirement planning is to achieve financial independence, so that the need to be gainfully employed is optional rather than a necessity.

The process of retirement planning aims to:

(1) assess readiness-to-retire given a desired retirement age and lifestyle, i.e. do you have sufficient money to retire; and

(2) to identify actions to improve readiness-to-retire.

Contents 1 Obtaining a financial plan 2 Modeling and Limitations 3 The Monte Carlo method 4 Other models

Obtaining a financial plan

In recent years, producers such as a financial planner or financial adviser have been available to help clients develop retirement plans, where compensation is either fee-based or commissioned contingent on product sale. Such arrangement is sometimes viewed as conflicting to a consumer's interest to have advice rendered without bias or at cost that justifies value. Consumers can now elect a do it yourself (DIY) approach, given the advent of a large, ever growing body of resources. For example, retirement web-tools in the form of simple calculator, mathematical model or decision support system have appeared with greater frequency. A web-based tool that allows client to fully plan, without human intervention, might be considered a producer. A key motivation beyond the DIY trend is based on many of the same arguments of Lean manufacturing process, a constructive alteration of the relationship between producer and consumer.

Modeling and Limitations

Retirement finances touch upon a motley of distinct subject areas or financial domains of client importance, including: investments (i.e. stocks, bonds, mutual funds); real estate; debt; taxes; cash flow (income and expense) analysis; insurance; defined benefits (e.g. social security, traditional pensions). From an analytic perspective, each domain can be formally characterized and modeled using a different class (computer science) representation, as defined by a domain's unique set of attributes and behaviors. Domain models require definition only at a level of abstraction necessary for decision analysis. Since planning is about the future, domains need to extend beyond current state description and address uncertainty, volatility, change dynamics (i.e. constancy or determinism is not assumed). Together, these factors raise significant challenges to any current producer claim of model predictability or certainty. Some might even adopt fatalism -- that the full scope of client issues, non-financial included, render the entire problem indeterminate, unsolvable, and meaningless.

The Monte Carlo method

The Monte Carlo method is a perhaps the most common form of a mathematical model that is applied to predict long-term investment behavior for a client's retirement planning. Its use helps to identify adequacy of client's investment to attain retirement readiness and to clarify strategic choices and actions. Yet, the investment domain is only financial domain and therefore is incomplete. Depending on client context and despite popular press, the investment domain may have very little importance in relation to a client's other domains - e.g. a client who is predisposed to the use of real estate as primary source of retirement funding.

Other models

Contemporary retirement planning models have yet to be validated in the sense that the models purport to project a future that has yet to manifest itself. The criticism with contemporary models are some of the same levied against Neoclassical economics. The critic argues that contemporary models may only have proven validity retrospectively, whereas it is the indeterminate future that needs solution. A more moderate school believes that retirement planning methods must further evolve by adopting a more robust and integrated set of tools from the field of complexity science.

This entry is from Wikipedia, the leading user-contributed encyclopedia. It may not have been reviewed by professional editors (see full disclaimer)

IRA

The Individual Retirement Arrangement (IRA) is a special, tax deductible account designed to help individuals save for retirement. These accounts are available through banks, mutual funds, life insurance companies, and brokerage houses. The funds deposited can be invested in numerous ways in order to earn dividends. These earnings are not taxed until they are distributed; if this falls after retirement, your tax bracket is likely to be lower.

The maximum contribution allowed by law is $2,000 per year. Withdrawals are permitted after the age of 59 1/2 and are required by April 1 of the year after you reach age 70 1/2. Early withdrawals are subject to a penalty of 10% in addition to any regular income tax. Certain types of withdrawals are exempt from this penalty, including those made for higher education, unreimbursed medical expenses in excess of 7.5% of your adjusted gross income, in case of disability, or towards the purchase of a first home.

A special type of IRA, called a Roth IRA, allows for contributions to continue after the age of 70 1/2 and funds can be left in the account indefinitely. Individuals with an income of less than $95,000 and couples with an income of less than $150,000 are eligible.

Employers can set up an IRA for you in the form of a Simplified Employee Pension (SEP). An employer is not limited by the $2,000 annual limit; the maximum allowed is up to 15% of the employee’s income up to $30,000.

A 401(k) plan allows an employee to contribute a percentage of gross income to an individual retirement account. This money is deducted before any taxes are paid, reducing your taxable income by up to 15%. Some employers match your contributions, in effect increasing your income while reducing your tax burden.

The plan is managed by the company and usually includes a variety of investment options from which you can choose. Whether you wish to invest in stocks, bonds, or a mutual fund is up to you and you can change the plan to suit your changing needs. Costs of managing the plan, including your own investments, are usually absorbed by the company.

If you leave a company before retirement, you will be able to keep some or all of the matching funds, depending upon the company’s policy. To avoid penalties, you will have to roll the money over into an individual or company-sponsored IRA. Some companies will allow you to maintain your original investment account but you will not be able to contribute any additional funds. Upon retirement you can cash in the account without penalty.

A 403(b) plan is similar to a 401(k) plan, but it is offered by nonprofit organizations such as hospitals, schools, or social service agencies. In either type of plan, the maximum annual contribution is $9,500 or up to 15% of your income, whichever is less.

Social Security is a government-sponsored retirement plan; contributions to Social Security are automatically deducted from the paychecks of every worker in the United States and deposited into a special fund.

Each year that you work, you earn credits toward your retirement based upon your income up to a maximum of 4 credits per year. To be eligible to receive benefits, you must be over the age of 65 and have earned more than 40 credits. If you continue working past age 65, you can still collect benefits, but only within certain income limits. After the age of 70 you can collect benefits with no income limits.

Keep in mind that the average monthly Social Security payment was $500 for an individual in 1999; while these benefits are helpful to retirees, they do not constitute a living wage. Other retirement plans are essential in order to live comfortably after the age of 65.

For more information about Social Security, contact the Social Security Administration: 800-772-1213 or www.ssa.gov.

Arnone, William J. Ernst & Young’s Retirement Planning Guide. New York: Wiley, 2000.

Holzer, Bambi, with Elaine Floyd. Retire Rich: The Baby Boomer’s Guide to a Secure Future. New York: Wiley, 1998.

Howells, John. Retirement on a Shoestring. Guilford, Conn: Globe Pequot, 2000.

Rye, David E. 1,001 Ways to Save, Grow, and Invest Your Money. Franklin Lakes, N.J.: Career Press, 1999.