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University of Nevada, Reno Analyzing Defined Benefit Pensions: How Do University of Nevada, Reno Analyzing Defined Benefit Pensions: How Do Various Distribution Methods Affect an Individual’s Financial Independence? A thesis submitted in partial fulfillment of the requirements for the degree of Bachelor of Science in Finance and Economics and the Honors Program by Alyssa Yocom Dr. Thomas Liesz, Thesis Advisor May, 2017 UNIVERSITY OF NEVADA THE HONORS PROGRAM RENO We recommend that the thesis prepared under our supervision by ALYSSA J. YOCOM entitled Analyzing Defined Benefit Pensions: How Do Various Distribution Methods Affect an Individual’s Financial Independence? be accepted in partial fulfillment of the requirements for the degree of BACHELOR OF SCIENCE, FINANCE AND ECONOMICS ______________________________________________ Thomas Liesz, Ph.D., Thesis Advisor ______________________________________________ Tamara Valentine, Ph. D., Director, Honors Program May, 2017 i Abstract Nearly one third of the U.S. population is between ages 50 and 79 meaning that they are nearing or currently in the early years of retirement. Individuals tend to seek financial planning advice as they plan for retirement. The baby boomer generation that is currently retiring worked when defined benefit pension1 plans were the most commonly offered company-sponsored retirement plan. 78 percent of state and local government workers were participating in a defined benefit pension plan and 49 percent of private companies with 500 or more workers offered defined benefit pensions (Rafter, 2013). A defined benefit pension plan is a type of retirement account where an employer agrees to a pre-specified payment amount to an employee at retirement. The payment of the defined benefit pension plan can be distributed in various ways. The retiree may take a lump sum, a partial lump sum and 50% joint survivor annuity, a single life annuity, or a 50% joint and survivor annuity. Defined benefit pensions will distribute as a 50% joint and survivor annuity by default. Existing research discusses trends in retirement and various investment techniques retirees should consider but there is no analysis on how defined benefit pension distribution methods may affect an individual’s financial independence. Financial independence is achieved when an individual has enough liquid assets to support his or her standard of living and cash needs through the end of his or her life. This thesis conducts a case study on a hypothetical married couple, John and Jane Doe, and uses financial plan scenarios to understand the effects defined benefit pension distribution methods have on an individual’s financial independence. 1 Any financial term used throughout this thesis is bolded and a definition is provided in Appendix A on page 28 ii Table of Contents Abstract ............................................................................................................................................ i List of Tables ................................................................................................................................. iv List of Figures ................................................................................................................................. v Chapter 1: Introduction ................................................................................................................... 1 History of Financial Planning ..................................................................................................... 1 Planning for Retirement .............................................................................................................. 2 Defined Benefit Pension Plans .................................................................................................... 4 Chapter 2: Review of Literature ..................................................................................................... 7 Common Financial Advice for Retirees ...................................................................................... 7 Retirement Investment Risk ........................................................................................................ 9 The Decline of Defined Benefit Pension Plans ......................................................................... 10 The Need to Understand Defined Benefit Pensions .................................................................. 12 Chapter 3: Methodology and Case Assumptions .......................................................................... 14 Methodology ............................................................................................................................. 14 Case Assumptions ..................................................................................................................... 14 General Assumptions ............................................................................................................. 14 Savings and Investment Assumptions ................................................................................... 15 Personal Asset Assumptions .................................................................................................. 17 Retirement Asset Assumptions .............................................................................................. 18 Income and Expense Assumptions ........................................................................................ 19 Defined Benefit Pension Distributions ...................................................................................... 20 Chapter 4: Components of a Financial Plan ................................................................................. 22 Tax Projection Report ............................................................................................................... 22 Cash Flow Statement ................................................................................................................. 23 Balance Sheet ............................................................................................................................ 24 Financial Independence Report ................................................................................................. 25 Chapter 5: Results and Conclusion ............................................................................................... 27 Results ....................................................................................................................................... 27 Discussion of Scenario 1: Lump Sum Distribution ................................................................... 28 Discussion of Results ................................................................................................................ 29 Significance ............................................................................................................................... 31 References ..................................................................................................................................... 33 Appendix A: Definition of Terms ................................................................................................. 37 iii Appendix B: Financial Plan Scenario 1 – Lump Sum .................................................................. 40 Tax Projection Report ............................................................................................................... 40 Cash Flow Statement ................................................................................................................. 45 Balance Sheet ............................................................................................................................ 56 Financial Independence Report ................................................................................................. 62 Appendix C: Financial Plan Scenario 2 – Partial Lump Sum & 50% Joint and Survivor Annuity ....................................................................................................................................................... 63 Tax Projection Report ............................................................................................................... 63 Cash Flow Statement ................................................................................................................. 68 Balance Sheet ............................................................................................................................ 80 Financial Independence Report ................................................................................................. 86 Appendix D: Financial Plan Scenario 3 – Single Life Annuity .................................................... 87 Tax Projection Report ............................................................................................................... 87 Cash Flow Statement ................................................................................................................. 92 Balance Sheet .......................................................................................................................... 104 Financial Independence Report ............................................................................................... 110 Appendix E: Financial Plan Scenario 4 – 50% Joint and Survivor Annuity .............................. 110 Tax Projection Report ............................................................................................................. 110 Cash Flow Statement ..............................................................................................................
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