How To Start Planning for Retirement
September 29, 2020
The United States Department of Labor’s Employee Benefits Security Administration (EBSA) states that only 40% of Americans have calculated how much money they’ll need for retirement. Even more surprising, EBSA reports that, as of 2018, 30% of workers who had the opportunity to contribute to an employer-sponsored retirement benefits plan were not participating. Knowing how to start planning for retirement involves more than being aware that savings are important; a secure retirement depends on understanding different types of retirement plans, how time affects money, and the various sources of supplemental income that may be available in retirement.
Set Goals and Do the Math
Determine how much income you believe you would need to live comfortably in retirement. Calculate for a few different scenarios: Will you be paying college tuition for your children? Will your home be paid off? Also, think about the lifestyle you hope to maintain—will you want to travel, pursue recreation and hobbies, or move to a smaller home? Determine a realistic amount of monthly income you believe you would need.
Assess your comfort with investment risk. Savers who have a long way to go before retirement can take on more investment risk because they have more time to make up for losses. If you can’t bear seeing the value of your investments decline, or if volatility in financial markets makes you seasick, you may want to opt for more conservative investments. Given enough time and the power of compounding, a conservative investment strategy can still pay off.
Do the math to determine how much you’d need to save to achieve your desired income in retirement. Be realistic about your rate of return—it’s much more likely that your money will earn an average of 5% over the years than a booming rate of 10% or more. In addition, healthcare costs are unlikely to go down and typically increase as we age. These can eat up an enormous percentage of assets in the event of catastrophic illness or a prolonged period of disability. Look into long-term care insurance and as you approach retirement age, and research Medicare supplemental or Medicare Plus health plans and what expenses they cover beyond what Medicare provides.
Setting aside money regularly in accounts that can grow over time is the most important principle of planning for retirement. The effects of compounding, even in a low-interest-rate environment, can pay off handsomely over the years. But, on its own, earning steady interest probably won’t grow your retirement accounts enough to support a comfortable lifestyle in retirement. A diverse mix of investments—typically available in defined benefit plans like 401(k) or 403(b) plans—will include funds in stocks for growth and value, in bonds for income and as a hedge against market downturns, and in real estate investments.
Minimize or Eliminate Taxes on Your Retirement Funds
Speak with a financial planner and insurance professional.
Contribute the Maximum To Your Employer Plan
Defined benefit plans offered by many employers allow employees to contribute money on a tax-deferred basis. This means that you determine an amount your employer will deduct from your paycheck each pay period to be placed into your retirement plan. These contributions reduce your taxable income in the year you make them. Withdrawals will be subject to taxes when you retire, but you will likely be in a lower tax bracket by then. Most employers also offer a “match,” where they will match the amount you contribute up to a specified percentage of your income each pay period; you may then be able to contribute an additional percentage that will add up to as much as 10% or more of your pay.
Pay Yourself First
One common technique for saving is the “pay yourself first” rule: this is a practice of setting aside some amount of income, however small, in savings for yourself before paying bills or doing any shopping. If you are fortunate enough to have a job with wages or a salary that doesn’t completely run out each month, choose a manageable amount of money to set aside in a basic savings account. Once you have built up a rainy-day fund equivalent to at least six months of living expenses, then you can begin to save enough to open a retirement account.
In recent decades, economic conditions have made it difficult for workers, especially younger workers carrying loads of student debt, to contribute anything at all toward retirement. When the economy stabilizes and more secure jobs are available, those who haven’t been saving can begin to catch up. Workers over 50 can make additional “catch-up” contributions toward their 401(k) plan.
Know Your Investment Options
Employer plans may offer many investment options. A core principle of smart investing is diversification. You want to define what percentage of your savings will be invested in which type of available option. Read your plan, understand your investment choices, and ask plenty of questions. Another important thing to understand about retirement planning is when your money “vests.” This refers to how long you must participate in your employer’s retirement plan before the employer contribution is irretrievably yours. Also, find out about how “portable” your retirement savings may be if you change jobs.
There are a variety of investment options that may work together to form a robust retirement plan. These include:
- Defined benefit plans – These include employer-provided 401(k) or 403(b) plans.
- Traditional pension plans – These are increasingly rare, but if you have one, make sure to learn all the rules or restrictions.
- IRAs – Both traditional and Roth IRAs are additional ways to save for retirement; contributions to traditional IRAs are tax-deferred, while Roth IRAs are composed of after-tax contributions.
- Social Security – Factor in expected social security income at the maximum retirement age. Use the Social Security Administration’s online calculators to determine how much Social Security income you may expect in retirement. It’s prudent not to count on Social Security payments as the sole source of retirement income.
- Annuities – Ask your financial advisor about the different types of annuities. Annuities provide a guaranteed minimum income, but they also tie up a substantial amount of savings. Some employer plans offer the option to contribute to an annuity over time as one of several ways to allocate your retirement savings. Figure out if an annuity fits with your overall retirement plan.
- Employment – Retirement doesn’t necessarily mean giving up work entirely. You may want to keep your hand in your business, take a part-time job for fun and social engagement, or launch an entirely new career. Learn the rules about income in retirement that could affect your Social Security payments.
Adjust as You Approach Retirement Age
Shifting asset allocation toward preserving savings and generating income, rather than investing in growth, is typical as retirement age nears. Consult your financial advisor about rebalancing your portfolio gradually as you approach your anticipated retirement age.
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Finally, do everything you can to leave your retirement accounts alone until you stop working. Hard times may sometimes require you to take an early withdrawal, but be ready for big tax penalties and a long road back to building up to what you had before you made a withdrawal. Avoid it if you can. Planning for retirement requires determining your vision for your lifestyle in retirement, setting goals, and sticking to them.