FIN 422 Week 1 Retirement Needs and Plan Types Example

Twenty-Six Employees and No Retirement Plan: Estimating What a Denver Design Firm's Staff Will Need and Comparing a SIMPLE IRA, a SEP, a 401(k) and a Cash Balance Plan

[Student Name]

University of Phoenix

FIN/422: Retirement and Benefit Planning

Week 1 Assignment

[Instructor Name]

[Date]

The firm, its partners and employees are composites written for a model paper; plan features and research findings come from the sources listed and are stated generally.

Ridgeline Design, a composite architecture and interior design firm in Denver, has two partners in their early fifties and 24 employees aged 24 to 61, with salaries from $42,000 for an office coordinator to $118,000 for a senior architect. The firm has never offered a retirement plan. Two strong designers left last year for competitors offering a 401(k) with a match, and Colorado's state auto-IRA program now requires employers without a plan to enroll their workers or offer one of their own. The partners asked what their people would need in retirement and which plan would help most. A retirement plan is a tool for producing income decades from now, so its design should start from the income, not from the forms. This paper estimates the need and compares the options.

How Much Income Is Enough?

Planners usually express retirement needs as a replacement ratio, the share of pre-retirement income needed to maintain a similar standard of living. Retirees no longer pay payroll taxes or save for retirement, and work costs fall, so the ratio is typically estimated at 70 to 85 percent of final pay, with lower-paid workers needing a higher ratio. For a representative Ridgeline employee, a 35-year-old designer earning $72,000, a 78 percent ratio means about $56,000 a year in today's dollars.

What Social Security Covers

Social Security replaces a larger share of income for lower earners. For a worker with steady earnings near $72,000, the benefit at full retirement age, which is 67 for anyone born in 1960 or later (Social Security Administration, 2025), would replace roughly 40 percent of pre-retirement pay, about $29,000 a year in today's dollars. That leaves about $27,000 a year to come from savings.

Sizing the Gap

Turning $27,000 a year into a lump sum depends on how long retirement lasts and what the savings earn. Assuming 25 years of retirement and a 2 percent real return during it, the designer needs about $527,000 in today's dollars at 67. Starting at 35 with nothing saved, and earning a 4.5 percent real return over 32 years, that requires saving about $7,700 a year, or roughly 10.7 percent of pay. A plan that combines employee deferrals with an employer contribution of 3 to 4 percent makes that achievable.

Are People Saving Enough?

Researchers disagree. Scholz et al. (2006) found that most households in their sample of older Americans had saved enough by an optimal life-cycle standard, though a minority had not. Other studies that use replacement ratio targets find larger shortfalls, especially for workers without access to an employer plan. Poterba (2014) noted that rising longevity, the shift from defined benefit to defined contribution plans and low saving by some groups leave many households exposed. Ridgeline's employees fall in the group with no workplace plan, where saving tends to be lowest.

Two Basic Approaches

A defined benefit plan promises a specific retirement income, typically tied to final or career-average pay and the number of years worked. The employer bears the investment risk and the risk that retirees live longer than expected. A defined contribution plan sets the contributions, and the retirement income depends on how they grow, so the employee bears both risks. Defined contribution plans have become the norm in private employment because their costs are predictable and they move with workers who change jobs.

Four Candidate Plans

A SIMPLE IRA lets employees defer salary up to a lower annual limit than a 401(k), requires the employer to match up to 3 percent of pay or contribute 2 percent for everyone and has minimal administration. A SEP is funded only by the employer, as a percentage of pay that must be the same for everyone, and is very simple, but employees cannot defer their own salary. A 401(k) allows higher employee deferrals, a choice of match formulas, loans and Roth contributions, but requires annual testing and filings unless designed as a safe harbor plan. A cash balance plan is a defined benefit plan that credits each participant's account with a pay credit and an interest credit, allowing large contributions for older owners, but it requires actuarial work and a funding commitment.

Cost and Administration

For a firm of Ridgeline's size, a SIMPLE IRA or SEP costs little to run, often a modest per-account fee. A 401(k) costs several thousand dollars a year for recordkeeping and administration, though new federal tax credits for small employers starting a plan offset much of that in the first years, as Week 3 examines. A cash balance plan adds actuarial fees and required annual contributions.

The Partners' Own Goals

The partners, aged 52 and 54, want to save far more than employees typically can, to make up for years of reinvesting in the firm. A SIMPLE IRA's limits would cap their savings. A SEP would require the firm to contribute the same percentage for every employee as for the partners, which would be costly at high rates. A 401(k) with a profit-sharing feature, and possibly a cash balance plan later, would let them save more while giving employees a meaningful benefit.

What Employees Said

Before choosing, the partners surveyed staff. Most younger designers said they would join a plan if the firm matched contributions, while several older employees asked mainly about catching up on years without saving. Two part-time drafters asked whether they would be eligible at all. The answers confirmed that a match matters for recruiting, that catch-up limits matter for the oldest staff and that eligibility rules need care, issues the next week takes up.

The Leading Option

Weighing employee needs, recruiting, the partners' goals and cost, the firm's leading option is a safe harbor 401(k) with an employer match and a profit-sharing component, with a cash balance plan considered once the firm's cash flow is steady. The following weeks will test this option against federal rules, contribution limits, Social Security timing and a full plan design.

Conclusion

A representative Ridgeline employee needs to save close to 11 percent of pay for 32 years to fill the gap Social Security leaves. Among the four plans, a SIMPLE IRA and SEP are cheap but limited, and a cash balance plan suits the partners but not yet the firm's budget. A safe harbor 401(k) with profit sharing best balances employees' needs, recruiting and the partners' goals.

References

Poterba, J. M. (2014). Retirement security in an aging population. American Economic Review, 104(5), 1-30. https://doi.org/10.1257/aer.104.5.1

Scholz, J. K., Seshadri, A., & Khitatrakun, S. (2006). Are Americans saving "optimally" for retirement? Journal of Political Economy, 114(4), 607-643. https://doi.org/10.1086/506335

Social Security Administration. (2025). When to start receiving retirement benefits (Publication No. 05-10147). https://www.ssa.gov/pubs/EN-05-10147.pdf