401K Early Withdrawal Calculator - DOC

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					What Students Should Know about
Retirement & Trusts!
By Richard Okumoto & Jackie Snell
    How much money will you need in retirement?
    Where will your money come from when you retire?
    Who do you trust?
What is retirement?
Retirement is something that happens after you quit working. For some it happens after
the magical age of 65. For some it may never happen.
Retirement brings more time to relax, travel, or pursue the things that interest you. It
means more personal time. This is made possible by having a source of money to
support you. Yes, you need a source of money to support you, since working fulltime is
behind you. Or is it?
What to do?
How much money will you need when you retire?
Most people hold a vague notion that retirement will be extraordinary, fun, and easy.
But, if you don’t plan for it and save for it, the reality of retirement may hold a dose of
struggle and anxiety.
Where do you start?
Like Budgeting, you must start with a goal. In this case the goal is to have enough
money to be comfortable when you are not working. The “Retirement Money Table”
can help you determine the amount of money you will need.
What is your lifestyle?
Knowing what your lifestyle costs you now is the first step in planning for retirement. If
you already have a budget, you are well on your way to know how much money you will
need in retirement.
If you don’t have a budget, yet, return to the budget chapter to figure out both what it
costs to live in the style to which you are accustomed, and also how much you are
saving each month.
Of course you aren’t letting yourself go deeper into debt each month! If you are, you
are currently eating up your house down payment, college for your children, and,
probably, the prospect of ever retiring. Go directly to the budget chapter and figure out
how bad the news is. Then fix the leaks and go to the debt chapter to figure out how to
pay off your loans.
What changes when you retire?
Now that you know what your lifestyle costs, give some thought to what will change
when you retire.
                                                                            Okumoto / Snell 1
Advisors used to tell people they would need less money in retirement than while
working. Is that still true? Perhaps retirees need fewer and less expensive clothing.
Perhaps you will own a house free and clear. On the other hand people are living
healthier as well as longer. Few people want to watch a lot of television in retirement.
Will one car suffice when you and your spouse are used to having two? Want to travel
in retirement? That may cost as much or more than house payments.
How will you spend your new-found leisure time? More and more, people find they
want a similar income in retirement as when they were working full time. It is important
to keep active socially, physically, and mentally in retirement.
If your spending habits in retirement are similar to your habits when you are working –
you will need inflation adjusted income when you retire!
What is inflation?
Generally prices of things increase over time. This increase is called inflation.
Example: some of us can remember when a dinner at Chez Panisse, in Berkeley, cost
$12 (without wine in1973). We thought that was really expensive. Today it is hard to get
a dinner from any restaurant, short of fast food, for $12. This week, as we are writing
(2010), we checked the menu at Chez Panisse. The prices this week run from $60 to
$951. What now buys you a meal in a special restaurant might keep you eating at home
by the time you retire.
Key point: everything is likely to cost more when you retire. It is important that you
account for inflation in retirement planning.
How much will things cost when I retire?
Nobody knows how much inflation will be in the future. The best we can do is look at the
past to see what the future might bring. Most estimates of average inflation run between
3% and 4% for the US. This is good enough for us, since the past only very roughly
predicts the future. If retirement is a long way away for you, this may work pretty well. If
retirement is close, well, there just isn’t much time for things to average out in the short
run.
Compounding rears its ugly head again. Unfortunately inflation isn’t as simple as
multiplying 3% or 4% by the number of years until you retire. Inflation is like credit card
interest: you have to pay interest on the interest.
Soon you will look at exactly how compound interest works, but for now there is a short
cut – it isn’t exact but neither is our estimate of what the inflation rate will be.
The Rule of 72: Divide the inflation (or interest) rate into 72. The answer is
approximately the number of years that your costs (or principal) will take to double.




1
 Just in case you are interested, according to the US Department of Labor that $12, 1973 meal should
cost $58.92 in 2010. Chez Panisse may have grown a little more upscale in the intervening years, or the
Department of Labor calculator may be a little conservative in its inflation estimate.

                                                                                    Okumoto / Snell 2
Retirement Money Table.
If        Time to           If you retire in this year   If you plan to live this long in
average double              most things will cost        retirement, things will cost 4
Inflation                   twice what they do now *     times as much as they do
rate is                                                  now
3%          72/3 = 24       2010+24 = retire in 2034     2034 +24 = 2058 still retired
3.5%        72/3.5 = 20.6   2010+21 = retire in 2031     2031+21 = 2052 still retired
4%          72/4 = 18       2010+18 = retire in 2028     2028+18 = 2046 still retired
      Others will cost even more than double – like, probably, gasoline
Think about this: As a student, the “still retired” column probably comes closer to your
“begin retirement” date. If you think you will be retired for 20 or so years, how much will
things cost?
So far the government raises Social Security each year by the amount of inflation for the
previous year. Of course, there are many ways to calculate the rate of inflation.
How about your 401K or other retirement accounts? That depends on how well you
invest. You will learn a lot more about investments later in this class. When thinking
about retirement, for now, keep in mind that OVER THE LONG run the stock market,
historically, has risen a little more than inflation.
You are lucky to experience this recession while you are young. You already KNOW the
stock market can go down. The closer you get to retirement the smaller the portion of
your savings that you should put into stocks. As you probably know, many older people
grew up with the stock market only going up, even in the medium term. Many have lost
a large chunk of their retirement money because they didn’t heed this simple rule of
thumb.
Rule of thumb: The closer you get to retirement the smaller the portion of your savings
you should put into stocks.
Where will your money come from when you retire?
There are three primary sources of money for retirement:
     1. Government sponsored retirement plans (sometimes called entitlement
        programs),
     2. Your personal savings, and
     3. Employer sponsored retirement plans.
I will add a fourth item,
     4. Annuity (we will discuss this in the insurance section)
Government sponsored:
The primary Government sponsored program is Social Security.




                                                                           Okumoto / Snell 3
The amount of the retirement benefit paid from the Social Security depends on when
you were born, how much you contributed while working, and your age when you begin
collecting benefits.
For people born between 1943 and 1954 full benefits are available if you wait until age
66 to begin collecting. For people born between 1955 and 1959 the full benefit age
gradually rises to 67. For all people born after 1959 it stays at 67. Partial benefits may
be claimed at age 62. The more you’ve contributed the more you will get. Right now
(2010) the maximum for a worker retiring at age 66 is $2,346 per month.
The primary qualification for retirement benefits from the Social Security program is to
have contributed for 40 quarters with minimum earnings of $1,090 in each of those
quarters.
Of course, the rules could change, though it doesn’t seem likely in the near future.
Personal savings:
Amounts saved from earnings, gifts, or any other sources are considered personal
savings. For retirement savings most people choose to use Individual Retirement
Arrangements (IRAs) or 401K accounts. Currently both are ways you can defer taxes
while you save for retirement. That means you pay the taxes when you withdraw the
money rather than when you earn it. Many people like these plans because they think
they will be in a lower tax bracket after retirement than before.
With a 401K account your employer withdraws from your paycheck an amount you
specify and deposits it in an account you have opened. With an IRA you make the
deposit yourself. One advantage of a 401K is that you never see the money, so you
aren’t tempted to spend it. It is an easy way to “pay yourself first”. There are several
types of IRAs, most feature income tax deferral, but not all. The best way to learn more
about IRAs is to visit http://www.irs.gov/publications/p590/ on the internet.
Another advantage of both IRAs and 401Ks is that there is a penalty for early
withdrawal. How can a penalty be an advantage? You are less tempted to withdraw the
money before you need it in retirement!
Employer sponsored:
Often employers sponsor a retirement plan for employees. There are several types of
employer-sponsored plans. Some employers match, or match some portion of, your
contribution to a 401K. If your employer has a matching plan, this really is free money
that you are passing up if you don’t contribute up-to the maximum amount matched. Be
sure to sign up as soon as possible and contribute the maximum amount.
Employee rule: sign up as soon as you can for a 401K and invest at least as much as
your employer will match.
For an in-depth look at employer-sponsored plans, a good place to start is a report by
the Spark Institute at http://www.sparkinstitute.org/content-
files/File/Benefits%20and%20Accomplishments%20FINAL%20April-09.pdf.
Here are some tips that should improve your retirement

                                                                          Okumoto / Snell 4
          Start saving early – the power of compound interest will help build your
           savings balance,
          Add the inflation factor to determine how much money you will need in the
           future,
          Ensure that you will have social activities in retirement,
          Retirement planning is more than money planning – it’s about family,
           friends, and health.
Who do you trust?
Trusts are legal documents that tell people what to do in case something happens to
you. It is important to understand that this can go beyond money, including
guardianship of your children. Most people do not need trusts for monetary reasons.
Children are the area of our focus.
How will you protect your children if something happens to you?
Many people avoid or postpone writing wills and trusts because we don’t like to think
about bad things happening. Don’t be superstitious. Planning for the worst does not
make the worst more likely. It is better to think of a trust as peace of mind. If something
terrible does happen you want to know that your children are in good hands. If you do
not appoint someone as a guardian (in case of your absence) the state of California will
appoint someone for you. Unfortunately, who they choose may not be your first or even
second choice. This is why it is important for you to prepare a trust when you have
minor children.
Do you need an attorney to prepare a Trust? The answer is “No.” Anyone can create a
trust. However, having an attorney prepare the trust documents provides the following
advantages:
   a) High likelihood the Trust document will hold up in court if questions arise
   b) Your peace of mind the Trust documents are prepared properly
   c) Only attorneys can provide legal advice and answer legal questions for you




                                                                         Okumoto / Snell 5

				
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