Retirement Planning
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Retirement planning describes the financial strategies individuals employ during their working years to ensure that they will be able to meet their goals for financial security upon retirement. Making sound decisions about retirement is particularly important for self-employed persons and small business owners. Unlike employees of some large companies, who can simply participate in the pension plans and investment programs offered by their employers, entrepreneurs must set up and administer plans for themselves and for their employees.
In recent years there has been a shift away from company-funded, defined-benefit pension plans. These plans were common within large firms during the 1950s through 1970s and into the 1980s. A defined-benefit pension plan is one in which the employer pays into and manages a plan based on calculations of how much the fund will need in order to provide an employee with a particular, defined post-retirement income. Such a plan guarantees all qualified employees with a predetermined retirement benefit. Many things have combined to cause a shift away from defined-benefit plans and towards defined-contribution plans. One of the more important of these, other than substantial demographic pressure that the retirement of the baby boom generation is having on all retirement issues, was the passage of an obscure provision in the Tax Revenue Act of 1978, the 401(k) provision. This provision went largely unnoticed for two years until Ted Benna, a Pennsylvania benefits consultant, devised a creative and rewarding application of the law, an application which became what is known today at the 401(k) plan.
A 401(k) plan is just one of various types of plans which fall under the umbrella of defined-contribution plans, as opposed to defined-benefit plans. A defined-contribution plan is one in which there is no guaranteed post-retirement benefit but rather a defined monthly or yearly contribution to a plan. How the plan's assets are invested and how much they are worth at retirement is not defined by the plans. Employees are responsible, in most cases, for investment decisions and the level of contribution made to the plan. With defined-contribution pension plans employees pay into the plan on a tax-deferred basis and in most cases, the employer agrees to a minimum contribution or agrees to match some percentage of the contribution made by the employee. Many business writers believe that this shift from defined-benefit plan to defined-contribution plan has helped to level the playing field for small businesses. Smaller companies are now able to offer the same type of retirement benefits as many larger employers.
Though establishing and funding retirement plans can be costly for small businesses, such programs also offer a number of advantages. In most cases, for example, employer contributions to retirement plans are tax-deductible expenses. In addition, offering employees a comprehensive retirement plan can help small businesses attract and retain qualified people who might otherwise
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seek the security of working for a larger company. The number of small firms establishing retirement plans grew during the 1990s, but small employers still lag far behind larger ones in providing this type of benefit for employees.
Retirement planning is a topic of interest to all Americans, not only to small business owners and entrepreneurs. The debate over whether Social Security will be available for the younger members of the current work force adds legitimacy to the need for early retirement planning. Longer life expectancies mean that more money must be set aside for retirement, while the uncertainty of investment returns and inflation rates makes careful planning essential. In fact, some experts recommend that individuals invest a minimum of 14 percent of their gross income from the time they enter the work force to guarantee a comfortable retirement.
Unfortunately, most of us are not doing this. In fact, most Americans approaching retirement in 2005 do not have enough to retire on according to Jack VanDerhei, Senior Research Fellow at the Employee Benefit Research Institute (EBRI). In response to an interviewer's question on the Public Broadcasting System's Frontline show, VanDerhei explained that most people approaching retirement now have about three times their annual salary saved for the post-retirement period. The EBRI recommends that a man have 6.3 times his annual salary available for post-retirement living and a woman 6.7 times her annual salary. (Women have a longer life expectancy than men and therefore need slightly more retirement savings.) Financial planners and insurance analysts recommend even higher retirement savings goals—10 to 15 times annual salary—as necessary for a reasonable retirement. What is clear in all studies on this subject is the fact that as Americans, we are not now saving adequately for retirement.
The Social Security...
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