Copyright © 2008, The McGraw-Hill Companies, Inc.
Second, retirement planning is a business issue that goes well beyond
preparing for your own retirement. Not all retirement programs are
directly connected to employment, but many are, and whether and what
kind of retirement plan a business offers its employees can be a signifi-
cant issue for the business. A company that offers good retirement benefits
has an advantage over one that doesn’t in attracting and keeping the best
employees. On the other hand, a company that offers generous retirement
benefits can find that the costs of providing those benefits may place it at
a competitive disadvantage, as many large American companies (such as
the major automakers) have found in recent years.
Last, with the “baby boomers” now reaching retirement and with the
responsibility for funding retirement falling increasingly to individual
Americans, the already massive financial services industry is likely to
become an even larger part of the business landscape. Many of the readers
of this book may find that the financial planning industry provides favor-
able career opportunities.
Many Americans take for granted that they will be able to enjoy a finan-
cially comfortable and secure retirement at a fairly young age. Meanwhile,
news stories with tones ranging from cautionary to alarming report that
most people are not doing nearly enough to reach this goal. Whether or not
this is true, a basic understanding of retirement planning would help all of
us to assess what we can and should be doing.Defined Benefit Plans
Most retirement programs fall into one of two categories: defined benefit plans and defined
contribution plans. A defined benefit (DB) plan is a retirement program that provides a
set income in retirement, which may be calculated on the basis of preretirement earnings,
years worked, retirement age, and/or the period of time for which benefits are guaranteed
to be paid. Defined benefit plans used to be considered the standard type of retirement plan;
when people talk about having a pension, they usually mean a plan of this type (though
technically the term pension does not have to mean a defined benefit plan). We will con-
sider DB plans first.
The income that a defined benefit plan provides in retirement is determined by a formula
set out in the documents that govern the plan (not surprisingly called the plan documents).
There are some legal restrictions on what types of formulas can be used, but within these
there is still quite a bit of variation from one plan to another. There are, though, certain
general principles that are typically reflected in benefit formulas. Benefit formulas usually
award a larger income to retirees who have more years of service than to those with fewer;
this is often accomplished by making years of service (the number of years the retiree has
worked while covered by the retirement plan) a part of the formula itself. Years of service
usually refer only to years of full-time service; part-time work may earn partial credit or
may not count at all, depending on the specific plan.
The following example will illustrate this type of formula.Example 7.1.1 A union retirement plan promises an income to union members
beginning at age 65 and continuing until death. The formula states that retirees who
have at least 5 years of service will receive a monthly income of $80 for each year of
service, up to a maximum monthly income of $2,000. Find the benefi t that would be
payable to a member who retires at age 65 with (a) 4 years of service, (b) 10 years of
service, and (c) 40 years of service.(a) Since the formula requires a minimum of 5 years of service, someone retiring with fewer
than 5 years would not receive any benefi t.(b) Following the formula, we fi nd the monthly benefi t would be 10($80) $800 per month.7.1 Basic Principles of Retirement Planning 307A fi nancially secure retirement requires sound
planning. © Steve Mason/Getty Images/DIL