RETIREMENT SAVINGS AND INCOME PLANNING

Transcription

1 Published by: KEIR EDUCATIONAL RESOURCES 4785 Emerald Way Middletown, OH FAX RETIREMENT SAVINGS AND INCOME PLANNING

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3 All efforts have been made to ensure the accuracy of the contents of this material. However, should any errors be detected, Keir Educational Resources would greatly appreciate being informed of them. We will post all corrections and clarifications on the updates page on our Web site at Information in this material is subject to change without notice. No part of this material may be reproduced or transmitted in any form or by any means or for any purpose without the express written permission of Keir Educational Resources Principal Knowledge Topics for CFP Certification Examination, Copyright 2015, Certified Financial Planner Board of Standards, Inc. All rights reserved. Used with permission. Certified Financial Planner Board of Standards, Inc. owns the marks CFP, CERTIFIED FINANCIAL PLANNER, and CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements. ISBN PRINT # All rights reserved 2017 Jack C. Keir, Inc., DBA, Keir Educational Resources Revised and Reprinted February Keir Educational Resources 52-BPA

4 INTRODUCTION For over 40 years, Keir Educational Resources has helped hundreds of thousands of insurance and financial professionals to obtain their professional designations. Over the last 20 years, Keir has produced supplemental study materials to help students complete the required courses at local universities and colleges in order to qualify to sit for the CFP Certification Examination. Keir also has comprehensive review materials for the CFP Certification Examination that have helped thousands of students to pass the CFP Certification Examination. While working with numerous program directors and instructors from universities and colleges across the country, Keir Educational Resources often receives requests for a book that can serve as the primary textbook for each course that is required by CFP Board Registered Programs. Program directors and instructors involved with these programs are frequently looking for textbooks focused specifically on the topics and learning objectives outlined by CFP Board. Keir is pleased to offer textbooks designed specifically for each of the courses included in CFP Board Registered Programs. Keir s textbooks are designed using our well proven methodology of structuring each book to follow the Principle Knowledge Topic List provided by the CERTIFIED FINANCIAL PLANNER Board of Standards. The topic list is the current basis for the CFP Certification Examination, and, along with the Student-Centered Learning Objectives released by CFP Board in 2015, is the basis for student learning in Registered Programs. This textbook covers Retirement Savings and Income Planning (Topics 52 62). Since this textbook is designed to follow the CFP Board s topic list and Learning Objectives, we are confident that students and instructors will find this unique format to be the most effective way to learn the skills required of a successful financial planner. While written with CFP Board Registered Programs in mind, this Income Tax Planning textbook is comprehensive and flexible enough to be used in non-cfp Board programs as well. This textbook includes nearly 500 multiple choice questions and case questions to help reinforce each topic. The multiple choice questions included in this textbook cover the full range of cognitive levels of questions that students will experience on the CFP Certification Examination. These include: (1) Knowledge/Comprehension, (2) Application, (3) Analysis/Synthesis, and (4) Evaluation. Although the CFP Certification Examination emphasizes higher level cognitive questions, a student needs to master lower level knowledge and comprehension questions in order to become proficient at answering the application, analysis, and evaluation questions. To provide the experience of working on cases, as will be required of students when taking the CFP Certification Examination, we have included comprehensive cases with multiple choice questions in the Appendix at the end of this textbook. Each of the topics contains a table identifying cases and questions covering material in that particular topic. Students should read the case in the Appendix and attempt to answer the case questions identified for that topic. The cases range from a few paragraphs of facts to comprehensive cases with 5 to 10 pages of detailed client information. The short cases are similar to the mini-cases that appear on the CFP Certification Examination, and allow students to start to build their ability to answer case questions. The comprehensive cases provide the student with the same level of difficulty as the comprehensive cases on the CFP Certification Examination. Although most of the multiple choice questions in this textbook were written by Keir Educational Resources, some of the questions have appeared on past CFP Certification Examinations and are reprinted here with permission.

5 Retirement Savings and Income Planning Topic 52 BIBLICAL APPLICATION We are honored that you have selected Keir Educational Resource s textbook with faith-based supplements from the Ron Blue Institute. We hope that you are equipped with a biblical overview and perspective as you study the competencies needed to sit for the national Certified Financial Planning Board of Standards, Inc. comprehensive exam. This set of materials includes sections that provide biblical principles and concepts within specific topics. These sections are noted by the following symbol: The biblical principles and concepts are short and practical for you as a Christian financial planner; however, they are not comprehensive in nature. We want to encourage you to seek more information about biblical integration into your financial planning practice by becoming aware of the work of the Ron Blue Institute and Kingdom Advisors. The Ron Blue Institute was founded in 2012 by Ron Blue in partnership with Indiana Wesleyan University. The Ron Blue Institute was created to build upon the writings and teachings of Ron Blue over the course of his 40 year career in financial services. Ron has written over 20 books and has been one of the most influential speakers on the topic of biblical wisdom and discernment in financial decision making. In addition to his writings, Ron has founded many organizations, including National Christian Foundation, Ronald Blue & Co., and Kingdom Advisors. The main focus of the Ron Blue Institute is to change the way Christians think, act, and communicate about money and money management. Kingdom Advisors, headquartered in Atlanta Georgia, is a professional organization that seeks to equip financial professionals with in-depth training within a tight-knit community of Christian financial professionals who integrate their faith with their practice. Just recently, Kingdom Advisors re-launched and re-branded their designation and training for their national Certified Kingdom Advisor, or CKA which can be obtained through Indiana Wesleyan University or Liberty University. More information can be found at This textbook offers you a one-year student membership in Kingdom Advisors, a community of financial professionals integrating faith and practice. See the insert for details on how to activate your free student membership, a $35 value. Again, we are honored that you decided to seek materials with faith-based supplements and hope that through these supplements you are able to draw a closer to God and make practical application of these biblical principles in your financial planning practice. Thank you and God Bless! 2017 Keir Educational Resources

6 Biblical Application pages are contributed by Dr. Justin M. Henegar. Dr. Justin M. Henegar, CFP, ChFC, CRPC, Executive Director of Research and Scholarship at the Ron Blue Institute for Financial Planning received his undergraduate degree from the University of Oklahoma, a Master of Business Administration degree from Oklahoma Christian University, and his doctorate degree from Kansas State University. Prior to his role with RBI, Dr. Henegar worked both as a financial advisor and Client Relationship Manager for multiple different Merrill Lynch offices in Oklahoma and Texas. Currently, Dr. Henegar s responsibilities include developing and cultivating the Institute s research agenda and curriculum development needs, focused mainly on those within academia. Dr. Henegar teaches both residential students and online classes in topics such as personal finance, financial planning, and corporate finance. Dr. Henegar and Ron Blue have recently published a college textbook titled, Biblical Financial Planning: A Biblical Worldview of Personal Finance.

7 Retirement Savings and Income Planning Topic 52 Title TABLE OF CONTENTS Page Retirement Savings and Income Planning (Topics 52-62) Topic 52: Biblical Principles and Application 52-BPA.1 Topic 52: Retirement Needs Analysis Topic 52: Biblical Principles Journal 52-BPA.2 Topic 53: Biblical Principles and Application 53-BPA.1 Topic 53: Social Security and Medicare Topic 53: Biblical Principles Journal 53-BPA.2 Topic 54: Medicaid Topic 55: Types of Retirement Plans Topic 56: Qualified Plan Rules and Options Topic 57: Other Tax-Advantaged Retirement Plans Topic 58: Biblical Principles and Application 58-BPA.1 Topic 58: Regulatory Considerations Topic 58: Biblical Principles Journal 58-BPA.2 Topic 59: Key Factors Affecting Plan Selection for Businesses Topic 60: Distribution Rules and Taxation Topic 61: Retirement Income and Distribution Strategies Topic 62: Business Succession Planning Appendix Gordon Case Appendix 1 Roland Case Appendix 10 Loomis Company Case Appendix 17 Kramer Transportation Services, Inc. Case Appendix 24 Sparks Case Appendix 29 Lytle Case Appendix 36 Beals Case Appendix 43 Edmonds Case Appendix 52 Mcgee Case Appendix 70 Michael and Diana Eastman Case Appendix 87 Kenneth and Laurie Perkins Case Appendix 98 John and Brianna Harrison Case Appendix 108 Selected Facts and Figures Appendix Topic List Appendix 160 Glossary Glossary 1 Index Index Keir Educational Resources

8 RETIREMENT SAVINGS AND INCOME PLANNING Topic Title: Retirement Needs Analysis Biblical Principles and Application Scripture Verse: The LORD God took the man and put him in the Garden of Eden to work it and take care of it. (Genesis 2:15) Scripture Verse: For even when we were with you, we used to give you this order; if anyone is not willing to work, then he is not to eat, either. (2 Thessalonians 3:10) Rethinking Retirement: One of the most significant parts of a financial planner s job is to discuss retirement and retirement strategies with clients. Using questionnaires and software, you will gather relevant information, such as the client s retirement goals, age, income expectations, and health. For each client, there will be an individual plan developed to suit the client s personal situation and preferences. Even though you will be called upon to plan many different retirements, the bible only speaks of one type of retirement, which is for the priests to leave their position at age 50 (Numbers 8:25). Although scholars may differ, it appears that retirement from a profession is limited to Priests, which means that other professions should continue to work and provide for their families (I Timothy 5:8). Due to sin, God established a new order which requires us to work to maintain His creation. Paul, Silas, and Timothy (2 Thessalonians) provide instruction that if we are not willing to work, we should not share in the fruit (eat). Having discussions with clients about retirement should lead to an inquiry into their attitude toward work and how they may follow Paul s wisdom. Even though people must work, there is still a need for retirement planning. By being prudent in savings (Proverbs 6:6), one may be able to pursue ministry opportunities and may be able to do so without requiring compensation for this work. What a great way to show the Lord your attitude by working with joy and knowing you do not need to be compensated. You should take the opportunity to talk to clients about their plans for retirement because this planning may really change their needs in retirement. The application of biblical principles to retirement planning suggests a change from a narrow focus on the ending of a career to a wider view of the continuance of work through the creation of a new career. This change may require a finding a new attitude and purpose for working. As you begin the topic content, seek the Holy Spirit and reflect on how you can articulate these biblical principles and your understanding of retirement planning in your client conversations. You will have the opportunity to reflect more on these principles at the end of this topic. Explore this topic further at

9 RETIREMENT SAVINGS AND INCOME PLANNING Retirement Needs Analysis (Topic 52) CFP Board Student-Centered Learning Objectives (a) Identify and evaluate the assumptions used in analyzing retirement needs including: age at retirement, cash inflows and outflows in various stages of retirement, goal priority and importance, longevity, rate of investment return, market volatility, and effects of inflation. (b) Recognize the potential sources of income during retirement including social security, employer plan benefits, personal savings and investments, individual retirement plans and employment income. (c) Calculate an appropriate savings plan to meet funding needs and communicate the importance of having a well-funded retirement plan. (d) Recommend a plan for maximizing the probability of achieving the client s goals and mitigating longevity risk. (e) Use statistical and probability techniques in calculating retirement funding and income distribution plans. (f) Explain various patterns of work-to-retirement transitions and phased retirement. Retirement Needs Analysis A. Assumptions for retirement planning 1) Inflation 2) Retirement period and life expectancy 3) Lifestyle 4) Total return B. Income sources C. Financial needs 1) Living costs 2) Charitable and beneficiary gifting objectives 3) Medical costs, including long-term care needs analysis 4) Other (trust and foundation funding, education funding, etc.) D. Straight-line returns vs. probability analysis E. Pure annuity vs. capital preservation F. Alternatives to compensate for projected cash flow shortfalls G. Phased retirement 2017 Keir Educational Resources

10 Retirement Savings and Income Planning Topic 52 Retirement Needs Analysis As the population ages, the emphasis in financial planning is shifting from planning for premature death to planning for a much longer retirement. Life expectancy has increased dramatically in the last century, making plans to retire for ten or fifteen years obsolete. Due to advances in medical science, the current length of retirement is closer to 25 years. In addition to increasing longevity, current retirees are less likely today than in the past to have defined benefit pension plans that promise a lifetime income from their employers. Instead, they are likely to be retiring with defined contribution plans, such as 401(k) plans, that will require the retiree to manage an investment portfolio and select a distribution rate throughout their retirement years. The decrease in employer-sponsored medical insurance coverage for retirees in recent years has also made planning for medical care expenses as well as long-term care expenses an essential part of retirement planning. Three Phases of Retirement Planning In retirement planning, there are three phases: accumulation, consolidation, and distribution. The accumulation of capital occurs during one s working years, roughly between ages 30 and 55. In the second phase, the phase of consolidation, the client restructures the investment portfolio to a more conservative allocation that will be subject to less fluctuation in asset value. The third phase is the distribution period when the retiree is collecting from private investments, Social Security, any employer-sponsored qualified or non-qualified plans, and individually directed qualified plans, such as IRAs and Roth IRAs. At each phase, there is an interaction between inflation and current interest rates, and this interaction can affect the outcome of how much one can accumulate and what the capital sum will yield at retirement. Yearly saving during one s working years is essential to accomplish the goal of building an adequate fund for retirement. A conservative objective would be to devote 10% of gross income to savings. That is a goal which many cannot attain. Rather than setting an unattainable goal and giving up, clients should select an attainable goal so dollars are regularly deposited into a savings or investment vehicle. Assumptions for Retirement Planning Calculations The financial planner will use several assumptions in the calculations. It is important that these assumptions be reasonable and acceptable to the client. The large number of assumptions and length of time from beginning the accumulation phase through the distributions phase will assure that some of the assumptions will be 2017 Keir Educational Resources

11 Retirement Savings and Income Planning Topic 52 incorrect; therefore, the retirement plan must be reviewed on a regular basis and adjustments made as appropriate. Inflation Rate Retirement Period and Life Expectancy Lifestyle (Distribution Rate) Total Return Income Sources The client needs to make assumptions of amounts of inflation during the accumulation period, as well as for the distribution phase in retirement. The effects of inflation over a long period, such as occurs in retirement planning, should not be overlooked or underestimated. The impact of inflation is significant and must be factored into the retirement plan. Clients need to determine how long they plan to be in retirement. In other words, clients need to make an educated guess on when they will retire and how long they will live. Clients can look to mortality tables (single or joint life tables) and then adjust this time up or down based on their health status and how long their relatives live. Conservative assumptions should be made. When looking at life expectancy tables, keep in mind that if the table tells you the life expectancy for a male who is currently age 65 is 19 years, that means that half of those who are currently age 65 are expected to die by age 84; but the other half will still be living. If the client is in good health and has a family history of longevity, odds are good that he will be in the 50% still living, so the plan should allow for income to continue beyond that age. Clients should determine how much they will need for living expenses in retirement. A client s lifestyle will be the biggest factor in determining this amount, especially if the client enjoys a high-society lifestyle or enjoys traveling the world. Clients should look carefully at retirement goals and prioritize them. They should identify goals on which they are not willing to compromise and goals they may be willing to reduce or replace. Clients should be aware that during retirement they may need to change goals when a shortfall is projected, when inflation is higher than expected, when medical costs are higher than anticipated, or when investments do not perform as well as expected. The retirement account balance will provide the annual income during each year of retirement. The total return rate will assume how the corpus of the account will grow during that period. As part of the retirement income analysis method, clients should project all reliable sources of income. This projection should include consideration of options under employer-sponsored pension or deferred-compensation plans and Social Security. If there are lump-sum settlements available from profit-sharing or money-purchase pension plans, clients should consider investing 2017 Keir Educational Resources

12 Retirement Savings and Income Planning Topic 52 Projection of Retirement Income (Financial Needs) these sums in growth investments to hedge against inflation. Striking a balance between conservative and aggressive investments is a challenge, particularly for retirees who have no current salary. There are two ways to set up a projection of desired retirement income: (1) Income replacement ratio (2) Retirement income analysis The income replacement ratio method requires a client to estimate a ballpark percentage of preretirement income which appears to be adequate to provide a standard of living at retirement, comparable to that being enjoyed before retirement. This method is appropriate when retirement is a decade or more in the future. The percentage of replacement income required has been found to decline as the client s current income increases: Client Current Earnings Replacement Ratio $15,000 to $60,000 72% to 82% $60,000 to $90,000 72% to 78% $90,000 to $120,000 60% to 75% These rough estimates should be refined as the client gets closer to retirement age and develops a consistent lifestyle and more predictable budget. The retirement income analysis method requires more systematic gathering of client information and should be used when the client approaches retirement. The client should be encouraged to put together a formal budget of expenses. A good place to start is to formulate a current cash flow or budget statement and then project any changes anticipated for retirement. A financial planner should help the client estimate the amount of income that will be needed during retirement to maintain the desired lifestyle. A client will need to recognize that during retirement, some categories of expenses will increase, some will decrease, some will stay the same, and a new category or two may be added. Continuing expenses will include food, clothing, and shelter, but the bottom line may change if the client decides to move into a retirement/assisted-living facility. Those expenses which may disappear are tuition payments, mortgage payments, 2017 Keir Educational Resources

13 Retirement Savings and Income Planning Topic 52 and car payments. Those expenses which may increase include prescription drugs and medical and dental care. New categories which might enter the picture are travel and entertainment, gifts for grandchildren, and charitable giving. One of the largest potential expenses a retiree may face is the need for long-term care. If these prospective expenses are not insured against within the plan, prolonged nursing home care can quickly consume all of the retirement assets. The long-term care discussion is an essential part of every retirement plan and should be documented, even if it is simply to note that the client has chosen not to address possible long-term care needs. The client s acknowledgement of this choice within the written plan provides some protection for a planner who may be accused of malpractice by that client s children later on when long-term care expenses have consumed all of the parents resources. The planner must assimilate all of these factors in determining the relationship between current expenditures and those anticipated at retirement. This process allows an initial projection of retirement income. For planning purposes, this income figure needs to be inflated to future dollars at retirement. Calculation of the First Year in Retirement Income Need For example, if the planner determines that the retirement income need in 28 years is $52,000 in today s dollars, that number must be inflated to equal the future dollars at the selected retirement age. If the planner determines that the Spencer family would need $52,000 of retirement income in today s dollars, subtracting $14,000 of Social Security income (in today s dollars) leaves a net amount of $38,000. Using a financial calculator, the planner then must inflate this income figure (pv), using the assumed inflation rate (i), and the number of periods to retirement (n), to arrive at its value at retirement (fv): N = 28 I = 3% PV = $38,000 PMT = 0 FV =? Solve for FV which is $86, Keir Educational Resources

14 APPLICATION QUESTIONS Use the following fact set to answer Questions 1-3. Paul and Lucinda Reynolds (ages 57 and 56, respectively) have determined that they will require retirement income equal to $63,000, based on current income. They plan to retire in 8 years and wish to assume an after-tax return on their investments, prior to retirement, of 8%. They plan to readjust their assets after retirement and believe that their net return will drop to 6%. Paul s parents are both in their late eighties, and Lucinda s parents are in their seventies. Paul and Lucinda assume that retirement will last for 30 years, and that inflation will average 2%. 1. What will be their first year s income at retirement? A. $63,000 B. $73,815 C. $79,807 D. $99,954 E. $116, What is the amount of capital necessary to support their income need? (Answer within $25.) A. $897,467 B. $1,077,007 C. $1,089,492 D. $1,288,655 E. $1,339, If the Reynolds decided to count their projected Social Security benefits of $14,251 in today s dollars per year, what would be the capital amount necessary? A. $1,036,247 B. $1,265,801 C. $1,444,781 D. $1,476,712 E. $1,539,971 ******************************* Use the following fact set to answer Questions 4-6. Phil Pattison wants to retire in 15 years at age 65. He has determined that he will need a capital sum of $2,354,000 at that time to provide his retirement income. He presently has a retirement plan with a balance of $350,000, to which he will add $26,000 per year. Phil assumes that his preretirement and postretirement rates of return will be 8%, and that inflation will average 3%. He will not consider Social Security benefits in his planning. He expects to live to at least age 80 but wants to use age 95 for all calculations. 4. How close will Phil come to his goal of a capital sum of $2,354,000? A. He will be short by $537,786. B. He will be short by $1,086,435. C. He will achieve his goal, with a surplus of $156,900. D. He will achieve his goal, with a surplus of $253,895. E. There is not sufficient information to determine whether he will achieve his goal or not Keir Educational Resources

15 Retirement Savings and Income Planning Application Questions Topic 52 For practice answering case questions related to Topic 52, please answer the following questions in the cases included in the Appendix at the back of this textbook. Case Questions Gordon Roland 1, 2, 3, 4, 5, 6, and 7 Loomis Company Kramer Transportation Services, Inc. Sparks Lytle Beals Edmonds 1 McGee 1 Michael and Diana Eastman Kenneth and Laurie Perkins 1 John and Brianna Harrison 1, 2, 3, 4, and Keir Educational Resources

16 ANSWERS AND EXPLANATIONS 1. B is the answer. Current income need ($63,000) should be adjusted by the inflation factor (2%) for the time period until retirement (8 years). To solve this problem on your financial calculator, you need to input: N = 8 I = 2 PV = 63,000 PMT = 0 FV =? Solve for FV which is $73, E is the answer. The capital required is calculated using a first year s income of $73,815, an inflation-adjusted rate of return of % [i = (1.06/1.02 1) x 100], and 30 years of retirement. To solve this problem on your financial calculator, you need to set the calculator for the begin mode and then input: N = 30 I = PV =? PMT = 73,815 FV = 0 Solve for PV which is $1,339, A is the answer. Since Social Security payments are inflation indexed, the $14,251 must be subtracted from the current value of $63,000. The result is then inflated to retirement and used to determine the capital sum necessary on your calculator with: N = 8 I = 2 PV = 48,749 PMT = 0 FV =? Solve for FV which is $57,117. The next step is to solve for the amount of capital based on this new payment amount. To solve this problem on your financial calculator, you need to set the calculator for the begin mode and then input: N = 30 I = [i = (1.06/1.02 1) x 100] PV =? PMT = 57,117 FV = Keir Educational Resources

17 Retirement Savings and Income Planning Answers and Explanations Topic 52 Solve for PV which is $1,036, A is the answer. The current plan assets with annual contributions will grow at 8% for 15 years, to a value of $1,816,214 ( end of year mode), which is $537,786 ($2,354,000 $1,816,214) short of his goal. To solve this problem on your financial calculator, you need to set the calculator for the END mode and then input: N = 15 I = 8 PV = -350,000 PMT = -26,000 FV =? Solve for FV which is $1,816, Keir Educational Resources

18 RETIREMENT SAVINGS AND INCOME PLANNING Biblical Principles Journal Take time to reflect on your scripture reading and its implications for this topic. Write down your thoughts and reflections, prayers, or ways you can incorporate these biblical truths into your counsel Keir Educational Resources 10