GOALS
What You Should Know About... Retirement Planning EMPLOYER PLANS CALCULATING YOUR NEEDS INVESTMENTS DECISIONS
Yo ur MoneyCounts™ No matter who you are or how much money you have, you’re probably hoping to enjoy a fi nancially secure retirement. Your retirement might be a distant, long-term goal—or it might feel as if it’s right around the corner. Either way, with a little planning, determination and some discipline, you can take the necessary steps to help you retire in comfort. You’ll fi nd there are plenty of tools you can use to make the most of your efforts.
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These are educational materials only, and are not to be used for solicitation purposes. These materials are not a recommendation by HSBC for any product, service, or fi nancial strategy. RETIREMENT PLANNING
you a lot of anxiety later, when you Funding your fi nd yourself closer to retirement. retirement Compound earnings When you retire, you’ll still need to support yourself. How will you Time is a crucial element when manage when you’re not receiving it comes to building a retirement a paycheck? Social Security will account—and the more time you likely cover some of your costs. have, the better. That’s because of You may have a pension from your compounding, or the way earn- employer. But those benefi ts alone ings accumulate when you reinvest will probably not be enough to them. For example, if, one year, let you live the way you’d like to you earn an 8% return on $10,000, in your retirement years. To help your new total is $10,800. If you ensure a fi nancially secure retire- earn another 8% the following ment, you’ll need a plan for putting year, the new base amount of some of the money you’re earning $10,800 earns $864, and your bal- now into savings and investment ance grows to $11,664. Because accounts for the future. your earnings have the potential to Even if you’re a long way from generate more earnings, the longer reaching retirement, and your pri- the process continues, the bigger mary goals are buying a home or impact each dollar has. In fact, paying for your children’s educa- after 30 years earning 8% annu- tion, you’ll want to begin retire- ally, your $10,000 could be worth ment planning as soon as you can. $100,627 before taxes. Taking small steps now, while time can work on your behalf, will save
3 RETIREMENT PLANNING
The power of Age Investor A Investor B compounding 25 $3,000 To take maximum advantage of 26 $6,300 the power of compounding, you’ll 27 $9,765 want to start saving for the future 28 $13,403 early. The chart shows the results 29 $17,223 of two investors, one who begins 30 $21,235 saving at 25 and another who waits 31 $25,446 until 35. 32 $29,869 Investor A sets aside $3,000 a year from the time he’s 25 to the 33 $34,512 time he’s 35. Over those ten years, 34 $39,388 he puts a total of $30,000 into that 35 $41,357 $3,000 account, earning 5% interest that’s 36 $43,425 $6,300 compounded annually. 37 $45,596 $9,765 Investor B also sets aside $3,000 38 $47,876 $13,403 a year from the time he’s 35 to the time he’s 50, and earns the same 39 $50,270 $17,223 5% annually compounded interest. 40 $52,783 $21,235 Over those 15 years he puts away 41 $55,423 $25,446 $45,000, or 50% more than 42 $58,194 $29,869 Investor A. 43 $61,103 $34,512 Compare what each has at the 44 $64,159 $39,388 age of 50. 45 $67,367 $44,507 46 $70,735 $49,882 A word to 47 $74,271 $55,527 the wise 48 $77,986 $61,453 Even the best plan 49 $81,885 $67,675 can’t guarantee you’ll 50 $85,979 $74,209 meet your goals. Things happen that you can’t predict. But making no plan at all leaves everything to chance.
4 RETIREMENT PLANNING
If you’re close to retirement, that amount should be fairly easy to calculate. But if you’re many years from retiring, how can you tell what you’ll need? One way is to use a retirement planning calcula- tor that takes a number of factors, such as infl ation and projected wage increases, into account.
Questions to ask You’ll need to identify the different sources of income you know Even though you’ll have: he saved more money, Investor B was • Will you be receiving a pension unable to catch up with from your employer? Do you Investor A’s early start. know how it will be calculated? • Do you save money in an em- ployer sponsored retirement savings plan? How much have Planning you accumulated? What will ahead this be worth when you’re ready to retire? Part of planning for retirement is • How much can you expect from calculating how much you’ll need Social Security? Check the to support yourself and the people annual statement that the SSA who depend on you. As a rule provides. It should arrive about of thumb, you can estimate that three months before your birth- you’ll need about day each year. 80% of your pre- • Do you contribute to a retirement income tax-deferred savings plan on to maintain your your own? What’s your standard of living. current balance? 80% of pre- And the amount • How much, if anything, do you retirement you need will already? have set aside specifi - increase over time cally for retirement in taxable income due to infl ation. accounts? 5 RETIREMENT PLANNING
Then, you’ll want to add up Taking the next steps the amount you expect to receive Once you know how much prog- from each source. Sometimes—in ress you’ve already made, you’ll the case of a pension, for ex- be able to start fi lling in potential ample—you’ll have a fairly clear gaps in your retirement plan. That picture. But it can be more diffi - may mean setting aside more of cult to estimate income from your your income now, and making tax-deferred and taxable savings investment decisions that will help plans. Because their returns are not to increase the value of your sav- guaranteed, what you’ll have avail- ings. You can tackle this task in a able will depend on how much was number of different ways, includ- invested, where it was invested and ing participating in a 401(k) or how those investments performed. other employer sponsored retire- ment plans, opening an individual retirement account (IRA), buying annuities, and putting more savings into taxable investment accounts.
401(k)s advantage of saving money on taxes now and building your retire- Saving for retirement might seem ment account for the future. like an uphill battle, but there are Both the money you put into many things you can do that both the account and any earnings it make the process easier and allow produces are tax deferred until you your assets to build more quickly. For example, you may have the How a salary option of saving for retirement through an employer sponsored retirement plan, such as a 401(k). 4HE MORE MONEY These plans are also known as YOU PUT IN A salary reduction plans, since you K PLAN can defer a certain amount of your pretax salary into your retirement account. You take home a little less, but you postpone income tax on the amount you put into your K account. So you have the double 6 RETIREMENT PLANNING
withdraw, usually in retirement. • You may have more control Tax deferral means your account over how your savings are has the potential to compound invested faster, since you don’t have to take • You don’t risk losing track of out any of your earnings to pay your savings annual income taxes. • You have a bigger base of money to invest if you consoli- Portable plans date your accounts, which may entitle you to additional benefi ts Another big advantage of a 401(k) from the new trustee of your and other salary reduction plans is transferred accounts their portability. That means that when you leave your job for any You do have the right to with- reason, you have the right to move draw the money you’ve contrib- the contributions you’ve made to uted to a 401(k) when you leave your account plus any earnings to your job, but that’s usually not the a new employer’s plan—if the plan best choice. You’ll owe income tax accepts transfers—or to an IRA. on the total amount you withdraw, While you may have the option to plus a 10% federal tax penalty if leave your account with your for- you’re younger than 59½. And you mer employer, at least for a while, have to start all over again to ac- being able to transfer the money to cumulate retirement savings. The a new account has some potential better plan is to keep the money advantages: invested in a tax-deferred account to help achieve your original goal—funding your retirement. reduction plan works
THE LOWER YOUR THE LESS TAX THE GREATER TAXABLE SALARY YOU PAY YOUR EARNINGS POTENTIAL
7 IRS 0!9 4/
Tax
7 RETIREMENT PLANNING
Thrift savings plan A word to the wise • if you work for the The details of 401(k) plans federal government or vary from employer to em- one of the companies ployer, but participating in a that offer them plan if it’s offered is almost SIMPLE if you work always something you’ll • for a company with want to consider seriously. fewer than 100 It’s easy to participate. You employees probably won’t miss the money you’re putting away. Each of these plans works in You’ll reduce your current much the same way that a 401(k) tax bill. And if your employer does, and each is just as benefi - matches part of your contri- cial to your retirement planning. bution, why would you turn You contribute part of your pretax down free money? salary, which reduces what you owe in taxes now, and you make investment choices for your assets, which accumulate tax-deferred Other earnings. Eventually when you retirement withdraw the money, usually after you retire, you owe tax on your accounts withdrawals at the same tax rate that you pay on other income. Your employer might offer a plan that’s similar to a 401(k) but has a different name. You might have Contribution limits access to a: There’s a government-imposed limit on how much you can con- • 403(b) plan if you tribute to your plan each year. For work at a school, 2005, the maximum contribution B hospital, or other non- is $14,000 for a 401(k), 403(b) or profi t organization 457 and $10,000 for a SIMPLE. • 457 plan if you work You can also make a catch-up con- for a state or local tribution of up to $4,000—$2,000 government in the case of a SIMPLE—if you’re 50 or older and your plan allows them. Thrift plan contri-
8 RETIREMENT PLANNING
bution limits vary Eligibility depending on the spe- cifi c plan, but are also Whatever retirement capped at $14,000. plan you’re offered, 3 In some cases, your you probably won’t be employer may limit able to participate your your contribution at a fi rst day on the job. In certain percentage of your salary. There most cases, you have to may also be a limit imposed on the wait to become eligible, people who earn more than $95,000. which usually happens Employees in that category are defi ned after you’ve been with by the government as being highly your employer for one compensated (HCE, or highly compen- year. Also, you must sated employee), and the percentage of usually be at least 21. salary they can contribute each year is But be sure to check the determined by the percentage of salary fi rst date you’ll be eli- that lower-paid employees of the same gible and be clear about company contribute. You have to what you have to do to abide by the restriction that sets the lowest limit. participate.
Matching contributions If you’re part of a plan that of- fers matching contributions, you’ll Tax advantages aren’t the only want to fi nd out what percentage of upside to participating in employer your contribution that your em- sponsored retirement plans. You ployer will add. Even if you can’t may get some free money! In afford to save the maximum you’re some cases, your employer may allowed to contribute, adding the also contribute by matching some most your employer will match lets portion of your own contribution. you maximize the free money. If your employer contributes cash For example, some employers to your account, you can invest add 50% of what you put in, or the added money as you like. 50 cents for every $1, up to 6% Some employers match contribu- of your salary. The more you add, tions with shares of the company’s up to the limit, the more matching stock. you’re eligible for. 9 RETIREMENT PLANNING
%MPLOYER *OB 2OAD
%MPLOYEE /NE THOUSAND AND
You contribute Your employer Total contributes 3% of $25,000 salary, 50% of your contribution, $1,125 or $750 or $375 6% of $25,000 salary, 50% of your contribution, $2,250 or $1,500 or $750 3% of $50,000 salary, 50% of your contribution, $2,250 or $1,500 or $750 6% of $50,000 salary, 50% of your contribution, $4,500 or $3,000 or $1,500
Vesting All the money you put into a tively, if your employer uses a cliff 401(k) plan is yours, and you can vesting schedule, you might be take it with you if you change jobs. fully vested after three years. The In most cases, though, you’ll have vesting period can be shorter, but it to stay at your job for a certain can’t be longer than six years. length of time, known as a vesting period, before any of your com- pany’s matching funds are yours Planning a move permanently. That means if you leave your job before you become Talk to someone in your fully vested, you won’t get to keep employer’s benefi ts depart- your employer’s contribution. ment if you’re not sure what Some companies use a graded the vesting rules are. If vesting schedule, which means you’re considering taking a you’re entitled to 20% of the new job, it’s worth investi- matched funds after two years. gating whether it might pay Your vesting percentage increases to stay with your current 20% each year, until you’re fully employer a little longer to be vested after six years. Alterna- fully vested.
10 RETIREMENT PLANNING
On the other hand, being will- Choosing ing to take some risk with at least 401(k) a portion of your account value increases the possibility of a stron- investments ger return and greater progress toward your fi nancial goals. And, While a 401(k) plan doesn’t usu- of course, the more time you have ally let you choose among all until you plan to retire, the more the investments available in the risk you can afford to take. You marketplace—which can be a may want to talk with an invest- good thing if you’re uneasy about ment adviser as you make these making investment decisions—you decisions. will have a range of selections from which to create your account portfolio. You’ll probably be able to choose from a variety of mutual funds, stable value funds, guaran- teed investment contracts (GICs), annuities and, sometimes, indi- vidual stocks and bonds.
One of the things that will infl u- Seeking diversifi cation ence the investment selections you One advantage of mutual funds is make is how much risk you’re that they offer instant diversifi ca- willing to take with your retire- tion. That’s the case because most ment plan account. Any invest- mutual funds make investments in ments that aren’t guaranteed or dozens of companies. For example, insured expose you to the possibil- instead of holding 1,000 shares ity of losing principal, especially in of one stock, a stock mutual fund a market downturn when invest- might own shares in 100 different ments of all or many classes tend stocks. Even if some of those 100 to lose value. stocks lose value at some point 11 RETIREMENT PLANNING &UND $ UAL IVER UT SIT - Y ).#/-%).#/-% 6!,5% 6!,5% &5.$ &5.$ '2/74( &5.$ "!,!.#%$ &5.$ "!,!.#%$ &5.$
while the fund owns them, oth- mutual funds that focus on growth, ers are likely to hold their own or others that seek income, and some increase in value. that do both by investing in both Diversifi cation is important stocks and bonds. For most people, because it may help you achieve spreading assets among several a portion of the return that you funds with varying goals and styles would have had by owning only is a good idea. the strongest performing invest- ments in any one period while What’s what? reducing the risk of losing money. The risk is reduced because you’ll The mutual fund choices you face never own only the weakest may seem very complex, but this performing investments in that short guide should help clarify same period. some basic differences. Most mutual funds concentrate their purchases on a certain invest- Mutual fund choices ment type because they have a Each mutual fund has a specifi c in- particular objective. Keep in mind, vestment goal and investment though, that the fund classifi cations style, tailored to meet the needs are subjective, and the category a of a particular type of investor. particular investment falls into de- While a 401(k) plan usually of- pends on the guidelines the mutual fers a limited number of funds, fund manager is following and the you may be able to choose some judgments he or she makes.
12 RETIREMENT PLANNING
How the fund hopes to profi t • Emerging market funds invest • Growth funds usually look for in developing economies that companies that have the poten- offer high potential return but tial to increase signifi cantly also carry signifi cant risk in value • Domestic funds invest in com- • Value funds look for companies panies based in the US that are currently not perform- • Global funds invest in both US ing up to their potential and international companies • Income funds invest to earn • Sector funds primarily invest regular dividend and interest in companies within a specifi c payments industry, such as energy, health- • Balanced funds invest in both care or technology stocks and bonds to reduce the risk of changing market Company stock conditions while providing a strong return You might be able to add shares of your employer’s stock to your What size companies the fund 401(k) or your employer may invests in make matching contributions in • Small companies that may be stock. While the stock may be a recent start-ups and offer more solid investment, you should be potential for growth, but also wary of concentrating too much more risk of losing money of your portfolio in one invest- • Large companies are usually ment, since a drop in price could older, more stable companies have a strong negative affect on that pose less risk of a major your savings. drop in price but offer slower In fact, it’s usually a good idea potential growth to keep no more than 10% of your • Mid-sized companies have 401(k) assets in your company’s some of the growth potential of stock. And you’re already depen- small companies but some of dent on the company for your the stability of larger companies salary, so if the worst happened and the company failed, you’d lose Where the fund invests your retirement savings as well as • International funds make your current income. You may also investments around the world, want to consider a similar guide- though not in the US, to take line for shares of your employer’s advantages of various economic stock that you might hold in other climates accounts. 13 RETIREMENT PLANNING
• You’re required to begin tak- IRAs ing withdrawals when you turn Whether or not you have a retire- 70½ and owe income tax at your ment savings account with your regular rate employer, you’re always eligible Traditional deductible for your own dedicated retirement • You qualify if either you aren’t account. An individual retire- eligible for a retirement plan at ment account (IRA) is an account work, or your modifi ed adjusted you set up and manage yourself. gross income (MAGI) is less You’ll have certain tax benefi ts, than $60,000 if you’re single or such as being able to defer taxes $80,000 if you’re married and on any earnings in the account, in fi le a joint return exchange for not withdrawing the • You can deduct your contribu- money until you reach retirement tion when you fi le your income age, but typically no earlier than tax return, which lowers your 59½. You choose the way you in- taxable salary vest your assets, so you can focus • Earnings in the account are on meeting your specifi c invest- tax deferred ment goals. • You’re required to begin tak- ing withdrawals when you turn Following the rules 70½ and owe income tax at your To contribute to an IRA, you must regular rate earn income. The only exception Roth is that if your spouse doesn’t earn • You qualify if your MAGI is an income and you do, you can less than $110,000 if you’re contribute to an IRA you set up single and less than $160,000 in his or her name as well as to an if you’re married and fi le a account in your own name. That’s joint return called a spousal IRA, and it’s • You contribute after-tax dollars controlled by the person in whose • You don’t owe tax on any name it’s established. earnings in the account as they There are three types of IRAs. accumulate Traditional non-deductible • You can withdraw your contri- • You contribute after-tax dollars butions and earnings tax free • Earnings in the account are if you’re at least 59½ and your tax deferred account has been open at least fi ve years
14 RETIREMENT PLANNING
tions of $500 in 2005 and $1,000 in 2006. And you won’t have to pay taxes on your earnings until retire- ment—or never, in the case of a Roth IRA if you follow the rules for withdrawal. That lets your money accumulate more quickly than it would if 4RADITIONAL NON DEDUCTIBLE you were paying taxes, and it 2OTH makes a big difference to your 4RADITIONAL account balance. DEDUCTIBLE Annuities Annuities are another retire- An IRA is easy to open—you ment savings option that you may can get the forms from your want to consider. Annuities are in- bank, brokerage fi rm, mutual surance company products that let fund company or other fi nancial you accumulate tax-deferred earn- services fi rm. Because you can ings and then convert your account invest your IRA assets almost any value to a source of income. You way you like, you’ll want to select pay premiums, or cash payments, an IRA provider that offers the to the insurance company—either choices you’re interested in. Your in one lump sum or in regular pay- list might include certifi cates of ments over time. You usually can’t deposit (CDs), mutual funds, withdraw without penalty before individual stocks and bonds or a you turn 59½. range of other alternatives. Annuities are available in many You can contribute up to $4,000 varieties. Some people use them to of earned income in 2005 and accumulate assets for their depen- another $4,000 in 2006—though dents, but most frequently they’re if you earn less than $4,000 you used to supplement other retire- can contribute only as much as you ment savings plans. Other people earned. If you’re 50 or older, you buy an annuity as a source of can also make catch-up contribu- immediate income.
15 RETIREMENT PLANNING
Deferred annuities: the sale of a business or an • Can be a way to save for inheritance future needs • Provides income that begins as • There’s an accumulation phase, soon as you sign the contract when you put money into the and pay the premium contract • When you’re ready to retire, The annuity you choose will there’s a payout phase when also depend on the return you’d your account value is converted like and the amount of risk you are to a stream of income or you willing to take. The choice here make some other withdrawal is between a variable and a fi xed arrangement annuity.
Immediate annuities: • If you choose a variable annu- • Appropriate if you’d like to ity, the rate at which earnings receive income right away accumulate in your account • May be purchased with a depends on the investment pension payout, proceeds from performance of the funds, called subaccounts, you choose from among #OMPARING !NNUITY #HOICES those the annuity of- fers. You’ll earn more 2ETIRING LATER 2ETIRING NOW when they’re doing well, and less when $EFERRED )MMEDIATE they’re doing poorly. !NNUITY OR !NNUITY • A fi xed annuity, on the other hand, #HANCE FOR &IXED RETURN offers you the same GREATER EARNINGS rate of return each month for a 6ARIABLE &IXED specifi c term. !NNUITY OR !NNUITY You can also choose an annuity as part of %MPLOYER /N YOUR OWN a qualifi ed retirement SPONSORED plan or decide to buy )NDIVIDUAL a nonqualifi ed annuity 1UALIFIED 2ETIREMENT AND with other savings. !NNUITY OR .ONQUALIFIED !NNUITIES RETIREMENT PLANNING
• A qualifi ed annuity is one mutual funds. You may qualify that you purchase through your to deduct your contribution 401(k) or other employer plan. when you fi le your tax return. Your contributions are made with pretax dollars and are sub- • A nonqualifi ed annuity is one ject to contribution limits and you purchase on your own, of- withdrawal requirements. ten when you’ve contributed as much as you can to an employ- • An individual retirement er’s plan or an IRA. Unlike annuity resembles a traditional 401(k)s or IRAs, there are no IRA in most ways, such as contribution limits and you’re contribution limits and with- not required to begin withdraw- drawal requirements. The als at 70½. In this case, you difference is that you purchase contribute after-tax income. an annuity rather than CDs or
Taxable • There are no limits on the amount you can add to your accounts taxable accounts each year In addition to special retirement • There are no limits on the kinds plans, you may also want to of investments you can make include regular taxable accounts, • There are no required such as a savings account or in- withdrawals vestment account, in your retire- ment portfolio. The one drawback Taxed at a lower rate is that you will owe taxes each What’s more, taxes on most stock year on any account earnings and dividends and most long-term on any capital gains, or profi t capital gains on investments from selling an investment for you’ve owned more than a year are more than you paid calculated at a lower tax rate for it. But there are than your regular tax rate, also potential advan- which applies to withdrawals tages that may out- from tax-deferred accounts. weigh owing some And you owe no tax on the tax now: increasing value of assets
17 RETIREMENT PLANNING you hold in your taxable accounts The bottom line until you sell them. Another point to consider is A well-thought out retire- that you may pay less in fees and ment plan is usually one other charges to buy, sell and hold that includes several savings investments in a taxable account vehicles, including: than you do in some tax-deferred accounts designed specifi cally for • An employer sponsored retirement savings. And if you plan, if available, such as a need to use some of your taxable 401(k), 457 or 403(b) retirement savings to meet an im- • Individual retirement mediate fi nancial need, there is no accounts (IRAs) 10% federal tax penalty. • Taxable savings and investment accounts • Employer pension Asset programs allocation • Social Security benefi ts All investments fall into differ- investments, you’re gaining protec- ent groups, called asset classes. tion, not only against a fl uctuation Stocks are one asset class, bonds in value that could wipe out your are another and cash or cash-equiv- savings, but also from infl ation that alents, like CDs, are another. The reduces your buying power. asset allocation you choose, which When you invest in many differ- is the way you divide your money ent types of investment accounts— among these classes, is key to from IRAs to taxable accounts— building a retirement portfolio that you want to allocate your assets can provide the long-term return across the range of your accounts. you seek, with the level of risk you So, for example, you might invest are comfortable assuming. your taxable accounts for growth It might seem as if putting all of and your IRA for income. Or you your money into investments that might try to allocate each account have the most growth potential or, across the available classes. It’s alternatively, into insured invest- up to you, and really depends on ments that protect you against many factors, including: losing principal, is the smarter approach. In fact, it’s a fairly risky • How many years you have approach. By making both types of before you retire
18 RETIREMENT PLANNING
How much money you have in • Retirement resources each type of account • Your personal tolerance for risk Your bank, brokerage fi rm or • Your current and anticipated mutual fund company may tax rates offer retirement planning • Infl ation services or refer you to a professional.
Doing the math You can learn about 401(k) The exact asset allocation that’s plans on the NASD website right for you depends on your (www.nasd.com) goals and your risk tolerance as well as the time you have until The Pension Benefi t Guaran- retirement. In general, the closer tee Corporation website has you are to retirement age, the a list of government agen- more conservatively you may cies that provide retirement want to invest. planning information (www. pbgc.gov)
Here’s an example of some You can search the informa- of the asset allocation tion available on the AARP models that you may see website (www.aarp.com) recommended for different stages in your investing life. What they show is a gradual movement from aggressive to conservative.
30 years to retirement: 80% stocks 10% bonds 10% cash 15 years to retirement: 60% stock 20% bonds 20% cash 5 years to retirement: 40% stock 40% bonds 20% cash
Remember, though, that models such as these aren’t designed to predict a particular level of return. While allocating assets can help you moderate risk, it doesn’t eliminate the possibility of accumulating less than you’d like. Also remember that an asset allocation isn’t fi xed—as time passes and you near retirement, you may want to consider shift- ing some of your stock holdings into more conservative choices to avoid the impact of short-term drops in the market.
19 RETIREMENT PLANNING
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