If the idea of getting ready for retirement makes you anxious or bores you to tears, don’t worry, you’re in good company. So, what exactly is retirement planning?
Retirement planning is a way to figure out how to manage your money so that you can enjoy your retirement years without financial stress. It’s all about learning and picking the right financial strategies that will help you feel secure during your retirement. When you have a well-thought-out retirement plan and manage it wisely, it can ensure that you have enough money to cover all your expenses in your later years.
Let’s delve into why planning for your retirement is crucial and analyze the necessary steps to get ready for your golden years.
Why should you plan for retirement?
Great news! People are living longer and staying active well into their later years.
However, many Americans haven’t saved or invested enough money to retire confidently in their 60s. Research from the Center for Retirement Research at Boston College and the Consumer Financial Protection Bureau shows that about 50% of today’s retirees are either cutting back on spending or will have to do so because they’re running out of money.
Sadly, too many retirees end up relying heavily on Social Security, only to discover it falls short. Social Security is designed to replace only about 40% of the average worker’s salary. Surprisingly, more than one in five married couples and 45% of single retirees depend on Social Security for over 90% of their retirement income.
In a nutshell, while some people manage without a formal retirement plan, those who truly enjoy their retirement usually do so because they’ve made one. Retirement planning is the key to ensuring you’ll be financially comfortable once you stop working.
What to consider when planning for retirement
Here are some important questions to think about when considering your retirement plan:
When do you want to retire? Are you aiming to retire at age 65, or do you have dreams of retiring earlier? The number of years you plan to keep working has a big impact on how much money you’ll require. If you work longer, not only will your investments have more time to grow, but you’ll also have fewer retirement years to fund.
Where do you want to live in retirement? Will you stay in your current home, or are you thinking about downsizing? Do you want to stay in your current area, or do you dream of retiring to a warmer climate or closer to family? The cost of living in your chosen retirement location is a significant factor that affects how much money you’ll need.
How will you cover your living expenses? Relying solely on Social Security income likely won’t cover all your expenses. Will you have a pension or a 401(k) to supplement your income? Do you plan to save or invest money for retirement? Additionally, the nature of your living expenses, like whether you own or rent a home, can also impact the amount you’ll need.
How much money do you really need to retire?
You might be curious about how much money you’ll need to enjoy a comfortable retirement. Well, there’s no one-size-fits-all answer. To figure out the amount that’s right for you, follow these simple steps:
Estimate your yearly expenses during retirement. A good rule of thumb is that most retirees need about 80% of their pre-retirement income to maintain their current lifestyle once they stop working.
Subtract your expected Social Security benefits and any pension income from your estimated yearly retirement expenses. You can find an estimate of your Social Security income on the Social Security website.
Multiply the remaining yearly retirement expenses by 25. This will give you a rough total of how much money you should save for retirement. This calculation is related to the 4% rule, which suggests not withdrawing more than 4% of your retirement savings annually to ensure your money lasts for at least 30 years.
How to save and invest for retirement
Saving money and investing it are two different things. When you save for retirement, you’re essentially putting your money to work, often by investing it in things like stocks. Just setting aside a part of your paycheck in a regular savings account won’t cut it if you want to reach your retirement goals. You need to put your money into assets that grow over time.
To highlight the importance of investing for retirement, consider this: If you save $5,000 every year in an account with a 1% annual interest rate for 35 years, you’d have about $208,000. But if you invested that same $5,000 each year, assuming an average annual return of 7%, your account could grow to nearly $700,000.
Remember, the returns you get depend on what you invest in. We recommend investing in stocks for long-term wealth building, while also keeping some money in cash.
Before you dive into investing for retirement, make sure you’ve set aside enough money in a high-yield savings account to cover three to six months of living expenses. This way, you have a financial safety net in case of unexpected expenses, and you won’t need to dip into your retirement savings. If you’re already retired, it’s a good idea to keep the money you expect to use in the next three to five years in bonds or cash for added financial security.
How much money should you save for retirement each month?
The amount you should save each month for retirement varies from person to person. It depends on your age, the age you want to retire, and how much you’ve already saved. But, as a starting point, most Americans can aim to save and invest around 15% of their incomes for retirement.
If setting aside 15% of your paycheck feels like a big leap, don’t worry, you don’t have to start there right away. At the very least, if your employer offers a retirement plan with matching contributions, contribute enough to get the full company match.
If you don’t have access to a retirement plan through work, consider saving 6% of your income, which is the average retirement contribution rate in the U.S. Then, gradually increase this percentage by 1% each year until you reach your desired savings rate. You can also bump up your savings rate whenever you receive a raise.
Types of retirement plans
There are various retirement plans to help you reach your retirement goals, each with its own perks. Here’s a breakdown of the main types:
- Employer-sponsored retirement plans: These are set up by your employer and often include employer contributions. The main types are:
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- 401(k) plan: You can put in money before taxes, but you’ll pay taxes on withdrawals in retirement.
- 403(b) plan: Similar to a 401(k), but typically for employees of public education, nonprofits, and ministries.
- 457 plan: Like a 401(k) but for state and local government employees and some nonprofit workers.
- Thrift Savings Plan: For federal government employees and uniformed services personnel.
- Pension plans: Pensions, often referred to as defined benefit plans, guarantee a fixed and dependable monthly income for life once you retire. While the availability of pension plans from companies is dwindling, they remain more prevalent among public sector employers.
- Individual retirement accounts (IRAs): These come in two flavors:
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- Traditional IRA: A retirement plan that allows tax-deductible contributions and regards withdrawals during retirement as taxable ordinary income.
- Roth IRA: A retirement plan where contributions are not tax-deductible, but withdrawals in retirement are entirely tax-free.
- Self-employed retirement plans: While they do involve some administrative responsibilities, self-employed individuals have several strategies at their disposal to access many of the same tax advantages associated with employer-sponsored retirement plans. Here are the retirement account options available to self-employed individuals:
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- SIMPLE IRA: Acronym for Savings Incentive Match PLan for Employees, SIMPLE IRAs serve as retirement savings plans for employers with 100 or fewer employees.
- SEP IRA: The Simplified Employee Pension IRA mandates employers to contribute 100% of the funds to the accounts and offer equal benefits to all eligible employees.
- Solo 401(k) plan: This retirement plan resembles employer-sponsored 401(k) plans but boasts a higher annual contribution limit.
These plans give you various ways to save and invest for your retirement, each with its unique benefits.
Tax benefits during retirement
When you’re saving for retirement, you usually have two options regarding taxes:
- You can pay taxes on the money you contribute to your retirement plan now, and then enjoy tax-free withdrawals in retirement.
- Or, you can put your money into a retirement plan before taxes, but you’ll be taxed on the money when you take it out during retirement.
Choosing the right retirement plan with tax benefits during retirement is usually a smart move if you expect your income in retirement to be higher than it is now.
The Roth versions of retirement plans offer these tax benefits during retirement. The Roth IRA and Roth 401(k) are quite popular, but you can also explore options like the Roth 403(b), Roth 457, or Roth solo 401(k). If you invest in an HSA (Health Savings Account), you can take out money for qualified medical expenses without paying income tax, both in retirement and before.
Even if you already have a 401(k) or traditional IRA, some states don’t tax the money you withdraw from these accounts, so you might be able to avoid state taxes on your retirement income.
Utilizing your residence to increase your retirement earnings
If you own your house, are getting close to retirement, and concerned about your retirement savings, there’s a way you might use the value of your home to boost your retirement income.
You can consider something called a “reverse mortgage.” This means a lender pays you money, kind of like a loan, using the value you’ve built up in your home. It’s not the right choice for everyone, but it’s worth looking into if you’re thinking about how to make your retirement finances work better.
Begin planning for your retirement now
Creating your retirement plan is a significant step, and there’s no need to worry, especially if you begin early. Think of it like planting a tree – the best time to start was 20 years ago, but the second-best time is now.
If you ever need help figuring out how to divide your investments, figuring out when you can retire, or designing your retirement income plan, consider reaching out to a Certified Financial Planner or another qualified expert. The key is to take retirement planning seriously and make a committed start today.
