A tax-deferred annuity (TDA), or simply a 403B plan, is a type of retirement plan designed to complement the employer’s base retirement plan (Teachers Insurance and Annuity Association of America, 2020). The contribution to the 403B plan is usually made before taxes. Thus, this retirement option reduces the current taxable income. Aside from the contribution being tax-deferred, any energy on the TDA plan is also tax-deferred (Teachers Insurance and Annuity Association of America, 2020). Thus, the savings have the potential to grow faster since the contribution and the investment earnings are exempted from tax until they are withdrawn as income upon retirement. This option may be a good choice, particularly if an employee expects the tax rates to reduce upon retirement (Teachers Insurance and Annuity Association of America, 2020). For the year 2020, the maximum allowable contribution to the plan is $ 19,500. If the new employee plans to retire at 60, the amount expected in her retirement account will be:
P= PMT × ( )
P= expected future estimation of the annuity stream
PMT= annual contribution
r= interest
n= 60-24= 36 years
P= $19,500 × ( )
P = $ 1,868,808
401K Retirement Option
The 401K retirement option is more or less similar to the 403B plan. Any person who has a year of service or more than 1000 hours is eligible to participate in the 401K retirement plan. Since the employee in question is more than 21 years, she has the option of partaking in this plan. Based on the 401K plan provision, an employee is allowed for participant loans and hardship withdrawals. The only problem is that it will create more administrative burdens for the employer. Participants are allowed to contribute up to 100% of the compensation or $ 19,500, whichever is lesser. Any person who is aged 50 years or older has an option to contribute an additional $6,500 catch-up deferral. By the time the employee will be 60 years old, she will have the following amount in her retirement account:
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P= PMT × ( )
P= expected future estimation of the annuity stream
PMT= annual contribution
r= interest
n= 60-24= 36 years
P= $19,500 × ( )
P = $ 1,868,808
Pension Retirement Option
If the employee chooses to go with the pension retirement option, she has the option of enrolling in defined benefit pension plans (OECD, 2006). If she chooses to go with a defined benefit pension plan, she will be assured of a specific monthly benefit upon her retirement. The amount of contribution to the program is flexible, depending on the employee’s preference. The benefits of such a pension retirement option are determined through a formula that is dependent on the employee’s salary and the length of employment (OECD, 2006). The amount of the benefit can be known beforehand based on the factor of age, earnings, and years of service. The employer will have the responsibility of facilitating the contribution necessary to fund the promised benefits. The annual valuation of assets and liability is used to determine the amount of contribution required from the employer (OECD, 2006). The pension benefit will be determined by multiplying a specific percentage, which cannot exceed 2% of the average earnings by the years of service. Therefore, for the 24-year old employee with an annual earning of $ 40,000, the annual pension upon her retirement will be:
$ 40,000 × 2% × 36 years = $ 28,800 per year.
Annuities
An annuity can be defined as a contract between an employee and a life insurance company. In return for a lump sum, an insurance company will pay the employee a fixed income for as long as she lives ( Bacinello et al., 2011 ). Upon retirement, the employee can buy an annuity with the amount that she has been saving throughout her working life using her pension arrangement. The primary advantage of an annuity is that it has a lower risk compared to other retirement products. Besides, the employee will be assured of a monthly income for as long as she lives. Besides, the employee has multiple annuity options that she can choose from, including the level annuity, a single life annuity, and a joint-life annuity, which gives the employee an option of buying an annuity for herself and a nominated survivor upon her death ( Bacinello et al., 2011 ).
Individual Retirement Account (IRA)
An IRA is an individual retirement plan that allows a tax-deferred saving for any worker aged below 70½ years (Chen et al., 2017). Any person with earned income, including those who are self-employed, is eligible to contribute to this scheme. The contribution limit for 2020 is $6000. The combined contribution to the traditional and Roth IRAs cannot exceed the maximum allowable contribution for the tax year (Chen et al., 2017). Employees are, however, required to make the IRA contribution before April 15 for it to be considered a prior calendar year contribution. The employee has the option of receiving a 5% interest on her savings or investing in the company stock and enjoy an annual rate of return of 4%. If she chooses the savings account, the new employee will have the following amount upon her retirement:
With an adjusted gross income of $40,000, an annual contribution of $6,000, and an expected rate of return of 5%, the employee will accrue a total of $616,976 as per an online calculator upon her retirement.
Estate Planning Retirement Option
An estate is all property and assets owned by a person or a group of individuals. Upon retirement, people start to contemplate what will happen to their wealth after they die. In many instances, people wish to pass their wealth to their loved ones and thus necessitating the need for estate planning. Estate planning is the process of developing a detailed plan for managing personal assets to optimize them while alive and ensure that they are wisely distributed upon death ( Garman et al., 2019 ). The first stage of estate planning is developing the estate through an asset acquisition, savings, investments, and insurance. The second part is ensuring that it is properly distributed to the beneficiaries, especially through a will or a trust.
Best Retirement Options
For the employee to achieve her target of $3 million upon her retirement, she will have to select more than one retirement option. The most suitable combination of options includes the 403B retirement option, the pension retirement plan, and an individual retirement account. The employee should choose the retirement options based on her current and expected future incomes, age, and aspirations upon retirement.
References
Bacinello, A. R., Millossovich, P., Olivieri, A., & Pitacco, E. (2011). Variable annuities: A unifying valuation approach. Insurance: Mathematics and Economics , 49 (3), 285-297.
Chen, A., & Munnell, A. H. (2017). Who contributes to individual retirement accounts?. Issue in Brief , 17-8.
Garman, E., & Forgue, R. (2019). Estate Planning. Personal Finance , 554-567.
OECD (2006). Financial education and saving for retirement. http://www.oecd.org/finance/private-pensions/39197801.pdf
Teachers Insurance and Annuity Association of America (2020). Your guide to 403(b) tax-deferred annuity or voluntary savings plans How much can you contribute in 2020? https://www.tiaa.org/public/pdf/pdf/your-guide-to-tax-deferred-annuities.pdf
