Page 534 - Introduction to Business

508 PART 5 Finance

Carole Lee volunteers at the Retired Senior Volunteer Program in Cleveland as a long-time social
worker and health educator.

The main risk that retirees face is inflation. Inflation erodes the purchasing
power of their savings. By definition, inflation is an increase in the prices of goods
and services. When people are in their working years, wage levels tend to rise as
inflation increases and workers thereby maintain their purchasing power. If wage
levels did not rise as inflation increased, people would find that they could not pur-
chase as many goods and services as before. In effect, they would become poorer
even though their annual income was the same. With no wages from a job, retirees
must protect themselves from inflation by investing in assets that grow over time in
value. Since stocks have higher long-run rates of return than bonds and real estate,
stocks dominate pension investment portfolios.
However, once a person retires, it is prudent to reduce the share of investments
in stocks and increase proportionately investments in bonds. The reason for this is
that stock prices are relatively volatile, whereas bonds offer more stable cash flow
payments. Retirees need the steady income of bonds to maintain their standard of
living. Nonetheless, some amount of stock investments is still warranted due to the
fact that people are living longer nowadays and must protect their income from
inflation for 10, 20, or 30 years after retirement. In sum, the mix of stocks and bonds
in a pension plan portfolio changes over time, with higher proportions of stocks in
a person’s younger years and higher proportions of bonds in retirement years.
Some other common pension plans in the United States are social security, indi-
vidual retirement accounts (IRAs), and self-employment plans known as Keogh
plans. Social security taxes are levied on all U.S. citizens’ wages. As contributors to
social security, U.S. citizens are entitled to social security benefits on retirement. It
unfunded pension plan A pension plan is important to note that the social security program is an unfunded pension plan
that pays retirees from cash flows or in the sense that taxes collected by the government are simply passed through to
taxes instead of from funds set aside
over time in a savings plan retirees, rather than invested in an account for an individual as in the case of a
funded pension plan. An IRA is a funded pension plan that allows individuals to
funded pension plan A pension plan
that pays retirees from their funds set save for their future retirement outside of an employer-sponsored plan. A Keogh
aside in a savings plan during their plan allows self-employed persons, such as small business employees and owners,
working years
to save for their retirement.
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