Explanation
There are two types of 401(k) Plans – the Traditional 401(k) and the Roth 401(k). Each has been explained here –
Traditional 401(k)
Withdrawal Rules
Roth 401(k)
Withdrawal Rules
The Rollover Process
Rollover refers to the process to be followed by you for moving your retirement savings plan to your Individual Retirement Account (IRA). It requires you to follow four steps to complete the rollover without incurring any income tax.
It is better to choose the Traditional IRA in comparison the Roth IRA, as Roth IRA is taxable and Traditional IRA does not attract any tax.
Select the best IRA account and a provider which aligns with your needs.
Direct Rollover means that your 401(k) Plan will directly pay into your new IRA account and not into your personal account.
Transfer of your 401(k) funds is made to the IRA as cash, you have to select the investment areas where you want the money to be invested.
Explanation
The most convenient contribution is 3% of the basic salary and this is equally matched by the employer. However, there is a maximum annual limit of $15,500 for contributions in the year 2007 which can be made by you and your employer will match this amount.
Calculations
Kevin is earning $72,000 as annual salary. If you contribute 15% of this, your monthly contribution will be $72,000*0.15 = $ 10,800 on this maximum 15% contribution. Your annual contribution will be $10,800*12 = $129,600. Since the Federal law permits only $15,500 every year on account of self-contribution for those below 49 years of age during the year 2007, hence you cannot go above this threshold limit. Your employer (Richardson Consulting) is to contribute up to 75% for the first 7% of Gross Salary contributed by you. This amount will be $72,000*7% = $5,040*75% = $3,780 per month. Annually, this amount will be $45,360.
It is stipulated that Richardson Consulting will be contributing 40% after 2 years, which will be $45,360*0.4 = $18144, which again is above the threshold limit of $15,500. Even after 3, 4 and 5 years, the contribution at 60% ($27,216), at 80% ($36,288) and at 100% ($45,360) respectively will be above the contribution thresholds.
The Federal Law permits that the employer can match up to the maximum limit, which is $15,500. This will make the total annual contribution of Kevin to his 401(k) Plan as $31,000.
Future Value for Kevin of this contribution is calculated using the formula –
FV = PV(1 + r)t, where
FV = Future Value
PV = Present Value = $31,000
r = Period Interest Rate (expressed in decimal) = 0.12
t = Number of Periods = 30 years
Future Value Interest Factor = (1 + r)t = (1+0.12)30 = 29.96
Hence FV for Kevin = PV x 29.96 = 31,000 x 29.96 = $928,760
Calculations
Amount in 401(k) account of Kevin at the time of his retirement will be $928,760. We assume that Kevin withdraws his annual amount at the end of the year, after the 5% interest earning has been credited to his 401(k) account. In case Kevin divides the retirement amount of $928,760 into 25 annual equated withdrawals, each year he will withdraw $37,150. The total amount available to Kevin every year for withdrawal will be the sum of this equated annual amount plus the interest amount earned each year in the account. The details are available in the table below.
Explanation
Megan’s Defined Benefit Plan
A Defined Benefit Plan, commonly known as pension, is the retirement account to which Megan’s employer (Northern University) contributes every month and promises Megan to get the pay-out when she retires.
Megan’s employer, Northern University, has put her under the Qualified, Non-contributory, defined Benefits Plan. Under this plan, Megan, at the time of her retirement, which is assumed at age 55, will receive benefits as per this formula – Annual Salary x 2.3% x Number of Service Years
Assuming that Megan retires at age 55 and assuming that she will have put in 32 years of service with Northern University. As per the details available Annual Salary of Megan is $52,000 and service years are 32. As per the formula Annual Salary x 2.3% x Number of Service Years, Megan’s Defined Benefit Amount at the time of her retirement will be
= $52,000 x 2.3% x 32 = $38,272.
Future Value for Megan, of this benefit, is calculated using the formula –
FV = PV(1 + r)t, where
FV = Future Value
PV = Present Value = $38,272
r = Period Interest Rate (expressed in decimal) = 0.05
t = Number of Periods = 32 years
Future Value Interest Factor = (1 + r)t = (1+0.05)32 = 4.76
Hence FV for Megan = PV x 4.76 = $38,272 x 4.76 = $162,175.
Assuming that Megan retires at age 55 and assuming that she will have put in 32 years of service with Northern University. As per the description Annual Salary of Megan is assumed to be $75,000 and service years are 32. As per the formula Annual Salary x 2.3% x Number of Service Years, Megan’s Defined Benefit Amount at the time of her retirement will be = $75,000 x 2.3% x 32 = $55,200.
Future Value for Megan, of this benefit, is calculated using the formula –
FV = PV(1 + r)t, where
FV = Future Value
PV = Present Value = $55,200
r = Period Interest Rate (expressed in decimal) = 0.05
t = Number of Periods = 32 years
Future Value Interest Factor = (1 + r)t = (1+0.05)32 = 4.76
Hence FV for Megan = PV x 4.76 = 55,200 x 4.76 = $262,752
Explanation
Megan’s 403(b) Plan
A defined contribution plan, like a 401(k) or 403(b), requires you to put in your own money. Hence, if you choose 403(b) Plan being offered by Northern University, you will make your own contribution for your post-retirement period. Most organizations offer the 403(b) tax-deferred retirement plan to their eligible employees so that the investments show a long-term growth, as is with a 401(k) plan. Contributions to this plan are generally in one of the following three forms:
It is assumed that Megan will chose the third option and contribute the maximum permissible amount of $16,500 annually. Hence, Northern University will also match the contribution.
Taxes and Distributions:
Income Tax on contributions and earnings from the 403(b) plan will be deferred until Megan withdraws money from the plan. All such withdrawals by Megan will be taxed as her regular income. Withdrawals will be allowed to Megan after reaching age 59 1/2. If she withdraws any amount from the account prior to her retirement age, then she may be charged a 10% penalty payable to the IRS.
Calculations
Under the 403(b) Plan, Megan’s contributions for the year 2007 will be $16,500, the maximum amount permissible to a contributor in this year. Accordingly, Northern University will also contribute the matching amount of $16,500 to her 403(b) Plan, making Megan’s total contribution to the plan at $33,000 for the year 2007.
Explanation
Annuity and Capital Preservation Model
Most individual retirement annuity contracts are tax-deferred or pre-tax based personal retirement plans. They are best for use of generating income for post-retirement of an annuitant and are usually invested in a fixed annuity or a variable annuity. Whereas
an Equity-indexed Annuity Plan is a contract between you and an insurance company. The combination of investment with an insurance product promises the investor a share from the stock market gains while limiting his losses when the market slumps.
When you make a lump sum capital payment, the insurance company offers you a return which is based on changes in the equity index, such as the S&P 500 Composite Stock Price Index. Guaranteed minimum return rates can vary. After the accumulation period, the insurance company makes periodic payments to you as per the terms of your contract.
Calculations
Taking into consideration the facts about the Browns, it can be assumed that their annual requirement of living expenses will be $90,000. From the information provided about them, the Brown’s shall be eligible for the following incomes post-retirements –
From Retirement Plans Monthly Income Annual Income
Bob Brown $2,300 $27,600
Margaret Brown $1,200 $14,400
Social Security Benefits Monthly Income Annual Income
Bob Brown $1,200 $14,400
Margaret Brown $900 $10,800
Annual Gross Total from both streams $67,200
Since the Browns have calculated their living expenses as $90,000 per annum, there is a shortfall of $22,800 ($90,000 – $67,200) every year.
Since it is assumed that Brown’s Retirement Life Expectancy (RLE) will be 30 years. Bob Brown will be receiving $2,300 every month from his Retirement Plan. This means that Bob Brown has an investment of $828,000 ($2,300 x 12 x 30) in his Retirement Plan. Margaret Brown will be receiving $1,200 every month from her Retirement Plan. This means that Margaret Brown has an investment of $432,000 ($1,200 x 12 x 30) in her Retirement Plan.
My recommendation is that they should shift their Retirement Plans to a better yielding investment plan, which gives them an additional income of $24,000 every year, so that their annual shortfall of $22,800 is covered.
Explanation
Below is given the list of important documents which every estate planner must prepare:
A will or trust should be among the main documents of your estate plan, although you may not have substantial assets. Wills ensure that the property is distributed as per the wish of an individual. You can create a trusts as they help in limiting the estate taxes or legal challenges. You must draft the will after consulting an expert as the wording of a will is critically important.
It is important that you draft a durable power of attorney (POA) in favour of an agent or a person to whom you assign the responsibility to act on your behalf when in circumstances when you are unable to do so yourself. I would recommend you draw a reciprocal power of attorney in favour of your spouse.
A number of your possessions or assets, such as 401(k) Plan, can be passed to your heirs, without being dictated in your will if you have declared a beneficiary. All insurance plans must have a beneficiary and a contingent beneficiary as well.
This is a document which you leave to your executor or the beneficiary. The purpose of this is to define what you want done with any particular asset after your death. Although this document does not have importance as a legal document, it can inform the probate judge about your intentions and would help in distributing your assets in case the will is found to be invalid for some legal reason.
Through the healthcare power of attorney (HCPA) you can designate another individual, usually your spouse or a close family member, for taking important healthcare decisions on your behalf in case you are unable to do so.
This is an important document, especially since you have a minor child. Selecting a guardian is very essential for the future of your child in case some mishap occurs with the parents.
09
Explanation
As per the calculations shown below, The Lee’s will be paying $38,100 after taking into account the annual inflation of 6%, the present value of which is $15,000. From the second calculations, we arrive at the amount of $11,108, which is required by the Lee’s to invest now so as to meet the first year education expenses of their son Mark, when he joins college 16 years from now. As Mark’s college education will be of 4 years, the Lee’s will have to invest $11,108 every year now, for continuous four years, to meet every year’s education expense of $38,100 which Mark will incur 16 years from now.
Calculations
Future Value for Mark’s Education expenses, after taking into consideration that it will be affected @ 6% annually due to inflation, can be calculated using the formula
FV = PV(1 + r)t, where
FV = Future Value
PV = Present Value = $15,000
r = Period Interest Rate (expressed in decimal) = 0.06
t = Number of Periods = 16 years
Future Value Interest Factor = (1 + r)t = (1+0.06)16 = 2.54
Hence FV for Education Expenses of Mark = PV x 2.54 = 15,000 x 2.54 = $38,100.
Future Value is known for education of Mark, but we need to calculate the Present Value (PV) using the formula –
PV = FV / (1 + r)t, where
PV = Present Value
FV = Future Value = $38,100
r = Period Interest Rate (expressed in decimal) = 0.08
t = Number of Periods = 16 years
Future Value Interest Factor = (1 + r)t = (1+0.08)16 = 3.43
Hence PV for Education Expenses of Mark = FV / 3.43 = 38,100 / 3.43 = $11,108.
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