Risks of Varying Retirement Plans

1. Risks of Varying Retirement Plans Group 6

2. Retirement Savings Plan • Definition: a plan for setting aside money to be spent after retirement. • Individual retirement account (IRA ) • contribute a limited yearly sum toward your retirement. • 401(k) • funded by employee contributions and matching contributions from the employer; the contributions are made from your pre-tax salary and the funds grow tax-free until they are withdrawn/converted into an IRA.

3. Inflation and Longevity Risks • Inflation reduces purchasing power and real value of savings • Life expectancy is increasing due to better medical treatments. • Best Case: • include inflation rate in your annuity payments and extend the lifespan of your payment in order to make sure that you have enough money to spend for your lifetime. (An increasing annuity) • Worst Case: • the real inflation rate is higher and you might live longer than you expected. You need to find other resources to cover your living expenses. • Likely Case: • In long run, you might need to put aside more money now. You need to have a well-structured increasing annuity plan.

4. Risk of Working Longer than Expected • Current and future retirees are planning for longer lives after retirement, and the most direct way to save more money is to do more work. Many companies will actually offer incentives for employees to push back retirement (but not during recession). • Best Case: • putting more of each paycheck into savings. • Ex: working an extra 3 years while saving 15% of your salary, it will raise your annual retirement income by 22% (The News Tribune). • Worst Case: • it becomes more difficult for younger workers to get into the job market/get promoted. • Likely Case: • an older employee demands more pay and keeps an opportunity away from a younger employee to be promoted.

5. Investment Risks • Compared to traditional pension plans and Social Security, personal savings plans give the employee the most freedom of choice in how they save their money. • Best Case: • You get to make the decisions regarding your own investments. • Worst Case: • Depends too much on the company’s savings plan model. • Ex: having a 401kplan that is invested heavily in your company’s stock is a plan that lacks diversity. • Long term: • Cycles in the market and the overall state of the economy will impact how people invest their money, but people are sure to keep investing in order to maximize their potential earnings.

6. Traditional Pension Plan • Definition: Type of DB pension plan managed and funded solely by the employer

7. Investment Risk • Funds for pension plans are typically invested in the stock market. Loss of funds can stunt future growth or lead to bankruptcy. • Worst Case: Stock market crash • Ex: GM • Best Case: Bull Market • Ex: 1983-2000 • Likely Case: Switch to DC plan

8. Longevity Risk • The longer the life of the employee, the greater the financial burden on the employer. • Worst Case: Underestimating life expectancy • Ex: cure for cancer • Best Case: Death of retiree soon after retirement • Ex: black plague • Likely Case: risk is manageable with good planning

9. Inflation Risk • Inflation decreases purchasing power of retirees • Worst Case: Large inflation after retirement • Best Case: Deflation • Likely Case: purchasing power will decrease somewhat

10. Public Policy Risk • Public policy dictates minimum amount of benefits, and can change at any time • Worst Case: • Employees: elimination of PBGC • Employer: requirement to adopt traditional plans • Best Case: • Employees: support for traditional plans • Employers: no minimum requirements • Likely Case: lower minimum requirements to support traditional plans

11. Government Benefits (Social Security) • Definition: Monthly government payments to retired workers or their families who have paid Social Security taxes for a total of 40 quarters or 10 years. • This comprehensive federal program of benefits provides workers and their dependents with retirement income, disability income, and other payments. The Social security tax is used to pay for the program.

12. Political Risk • Changes in policies and tax rates • The crisis ahead: “There is no way the government can fulfill the current promises without raising taxes or borrowing trillions of dollars. Starting 2018 Americans will be taking more money out of the system in the form of benefits than they are contributing through payroll taxes” Former President Bush • Worst and Best scenarios: Tax increase or benefits cuts

13. Demographic Risk • Baby boom factor • Number of beneficiaries vs. Number of contributors • Worst and Best Scenarios: Inability of the government to support current plan or increase in fertility

14. Life Expectancy and Longevity Risks • Increasing life expectancy • Consequences of mortality changes • Consequences of life expectancy increase • Longevity • Those who die early will receive fewer benefits, and those who live long may receive more than they paid in. • Worst Case: beneficiary dies just before they can withdraw funds. • Best Case: beneficiary lives much longer than expected and withdraws more than they contributed. • Likely Case: life expectancy is 77.5-80 years, so benefits will approximately equal contributions.

15. Rate of Return Risk • The rate of return for Social Security plans can be comparatively low. • Worst Case: beneficiary does not have a diverse portfolio, and funds are lacking. • Best Case: beneficiary has multiple sources of retirement funds with high rates of return. • Likely Case: recently, many retirement funds have lost much of their value due to market instability. Rates of return are likely to be poor.

16. Retirement Age Risk • Benefits can be altered by retirement age. • Worst Case: beneficiary retires early, reducing benefits. • Best Case: beneficiary retires on time and receives maximal benefits. • Likely Case: beneficiary must work longer than originally planned and will thus receive more benefits.