Retirement planning essentials
Enjoying your golden years is among every adult’s biggest dreams. Being able to put a lifetime of work behind you, travel, spend time with family, volunteer, and pursue your favorite hobbies is what retirement should be all about.
The hard truth is that many adults have failed to plan and save adequately for their retirement. In fact, recent studies have shown that only six in ten adults have anything saved for life after work.
If you have not built an adequate nest egg, your dream of a comfortable retirement could turn into years of extended work and financial stress at a time when you need money for living along with potentially increased medical costs.
Are you prepared?
While your retirement years might seem to be decades away, the time to start is now. Building a large nest egg might seem like an impossible task. It’s not. Even on a modest income, starting your saving early in your adult life and creating good habits to contribute to your retirement fund every year will grow and compound at a dazzling rate over time.
But how? It all starts with a plan and the discipline to contribute to your retirement year after year. We’ll show you how.
Set your retirement goals.
It’s time to get a pencil and paper (your laptop or tablet is just as good), think about, discuss, and define your retirement goals:
- At what age do you want to retire?
- What do you want to do during your retirement? Play? Volunteer? Travel? Think of what you look forward to doing when your working days are over.
- How many years do you expect to live in retirement (i.e., what is your life expectancy)?
- What lifestyle do you want when you retire?
- What insurance will you need to cover your health and other needs in retirement?
- How much monthly income will you need to maintain that lifestyle?
- Which income sources are you using (Social Security, pension, 401(k), IRA, investment earnings, rental property, home equity, etc.) to fund your retirement?
- How many years do you have left to save?
Your written plan will be your roadmap to a happy retirement. Share it not just with your spouse or partner, but also your family and financial advisor. Don’t just put this away in a drawer to be forgotten; schedule to review your plan annually to track your progress and adjust your goals as you advance toward your retirement.
Get an early start.
One of the biggest regrets American workers have is that they started too late on setting money aside for retirement. Many of us live for the here and now, not worrying about the future until it’s too late. We let ourselves get distracted by our desires — flashy clothes, a new boat, skis, or golf clubs, a big new TV, expensive nights out, you get the idea. With a little frugal discipline, saying no to a temptation and putting that money into a savings fund, your retirement investments can pay off dramatically over time.
It’s hard to imagine but a diligent saver even on a modest income who starts putting money aside for retirement in their 20s can often retire earlier and with a much bigger nest egg than someone making a significantly higher income but who got serious about retirement savings in their 40s. The reason? The magic of compounded interest.
How can that be? Take a look at the chart below from JP Morgan. It compares people who saved $5,000 annually. Two started at age 25; another at age 35. The difference in how much you can save with a 10-year head start is astonishing:
Source: J.P. Morgan Asset Management
In another example, to reach a goal of $1 million in retirement savings, the chart below shows how much you would need to save if you start investing at different ages. The earlier you begin, the less you need to put aside each month. By making savings a habit, you can painlessly build a gigantic nest egg.
Source: Business Insider
How much will you need for your retirement?
A good place to start is to look at how much you need for your current monthly expenses and lifestyle. Many financial planners recommend targeting a retirement fund that will let you live on 80 to 85 percent of your current salary to maintain a comfortable lifestyle during retirement. Using some planning tools will help you visualize what you need and along with your progress:
- Financial Finesse has a downloadable Budget Planning for Retirement worksheet to estimate your retirement expenses.
- The Balance has an excellent article on how to prepare a retirement budget.
- Use a retirement calculator. Bank of America/Merrill-Lynch has an outstanding retirement calculator to help you estimate where you are and how much you will need to save to live comfortably after your working years. Two other excellent tools are Vanguard's Nest Egg Calculator and the Fidelity Retirement Score. We highly recommend these.
To get the most from these excellent retirement planning tools, gather the following information:
The most recent statements and/or current account balances for all retirement accounts, including employer-sponsored retirement plans (401(k), 403(b), pension plans, etc.) and IRAs.
The total amounts that you plan to contribute annually to your retirement accounts.
The estimated rates of inflation and average annual return expectations you will use for your calculations.
The income levels you want to have during your retirement.
Use the Social Security retirement estimator to estimate your future Social Security income.
Getting an early start in using these tools and checking back to them periodically can help you make the necessary adjustments to keep your retirement goals on track. They can help you make career decisions that can boost your income, and wisely manage your expenses to help you retire comfortably.
There’s a great retirement account for practically everyone.
Okay, you have a plan and the tools to stay on course for a great retirement. The next big step is planting your financial garden. The good news is that the federal government has created several tax-advantaged retirement savings plans that can not only help you save for retirement but can also dramatically reduce the bite of your annual taxes. Our advice: Be smart and take full advantage of every option that you can. These include:
- Individual Retirement Accounts (IRAs) and Roth IRAs
- Employer-sponsored 401(k), 403b, and 457 plans
- If you are self-employed, a SEP IRA, Simple IRA, Keogh Plan, or Solo 401(k) plan can provide a similar path as employees of larger companies
Three beautiful words: Tax-deferred income. Whichever plan you choose, the great benefit is that your contributions are on a pre-tax basis, so they directly reduce your taxable income. These are tax-deferred investments, meaning that you won’t pay taxes on the gains until you are ready to withdraw the funds.
It makes sense to defer and invest as much as you can, especially if you are getting a later start. You won’t feel the deduction from your paycheck, but over time, as your investments grow and compound, you will be pleasantly surprised to see your earnings turn into a wonderful future.
Oh, and did we mention employer matching? On average, employers offering matching programs will contribute around 3 percent. That doesn’t seem like much, but it’s actually quite dramatic. If you work for a company that offers this benefit, it is a powerful tool to help you accelerate the growth of your retirement fund. Don’t pass this up.
How much should you put aside? We recommend trying to save between 10 and 20 percent of your income for retirement. Even the difference of one to two percent over many years can put the growth of your retirement nest egg on afterburners.
You can take it with you. Changing jobs? Good news! Most employer-sponsored retirement plans are portable. This means the savings that you built up by participating in a 401(k) at your old company, for example, can be transferred (e.g., rolled over) into a traditional IRA or your future employer’s retirement plan without any tax consequences.
Consider Health Savings Accounts (HSAs). Health savings accounts provide excellent tax benefits for out-of-pocket healthcare expenses. They can also be used as a supplemental source of retirement income. If you have a family or known health issues, an HSA is an option to consider, not just to keep your medical costs in line but also for their tax benefits.
Get the help from the IRS. (Seriously.) The IRS gives low-income taxpayers money to contribute to retirement plans.
Currently, the IRS has a Saver’s Credit called the Retirement Savings Contribution Credit. This tax credit is for taxpayers with Adjusted Gross Income under $31,500. The tax credit can be between 10% - 50% of your retirement contribution. This is a great opportunity for certain taxpayers to have the IRS help fund their retirement.
Meet your new friend: The Individual Retirement Account (IRA). Whether you participate in an employer-sponsored retirement plan, one option we strongly recommend is participating in an IRA. These come in two flavors: The traditional tax-deferred IRA and the Roth IRA. You can make annual contributions to either plan, and you can also roll over a 401(k) or similar savings plan into a traditional IRA (for example, if you move from one job or another).
If your employer does not offer a 401(k) or similar retirement plan, you may be eligible to fund either a traditional IRA or Roth IRA. Whether or not your employer offers a retirement plan, it isn’t your only investment option when it comes to saving for retirement.
A traditional IRA is tax-deferred, so you won’t have to pay any taxes on your earnings from this account until you withdraw the funds during your retirement. Compared to a taxable savings account, the big benefit is that you can accumulate more in an IRA because you are able to defer taxes on the interest and dividends earned by your IRA’s investments. In addition, because you will be retired when you begin your withdrawals from your IRA, it is likely that you will be taxed at a much lower rate when you redeem.
By contrast, the newer Roth IRA is a non-deductible retirement savings vehicle. While a Traditional IRA is tax-deferred, a Roth IRA provides potentially tax-free growth of retirement savings and distributions. When you participate in a Roth IRA, there is no tax deduction at the time of your contribution. The upside is that when it comes time to withdraw from your Roth IRA, your distributions (both principal and earnings) are tax-free, as long as you meet certain conditions.
As a result, you may be able to accumulate more in your Roth IRA than in a taxable account because you are not paying tax every year on the interest and dividends you earn along the way. Also, if you do not need to lower your taxable income or anticipate being in a higher income tax bracket during retirement, a Roth IRA is worth considering.
Note: Some income limits and other restrictions apply in order to deduct the contribution or to contribute to a Roth IRA, so make sure that you are choosing the best IRA for your situation. Be sure to do your homework to determine which IRA is best for you. Before you proceed, consult with your tax and/or financial advisor to get insightful advice.
Self-employed? Operate a small business? There’s a retirement plan for you too. If you are self-employed or a small business entrepreneur with a few employees, the federal government has set aside several self-employed retirement plans that offer similar tax-advantaged retirement savings that employees of larger companies enjoy. These include:
Even if you are a sole proprietor, we urge you to take advantage of one of these plans to build a successful retirement. Your tax or financial advisor can help you understand your options.
Insurance and Annuities. If guaranteed income is important for your retirement, many insurance carriers and some financial advisors offer annuity products. For example, annuities offer tax-deferred growth and income plans. But before you sign on the dotted line, review the details carefully and consult with a tax or fee-based financial advisor, as some annuities could prevent you from moving your investments later.
Taxable investment accounts. Ideally, saving as much as you can in a tax-deferred retirement investment account can help you shelter the funds you will need in your golden years. But taxable investment accounts like a regular brokerage account is valuable for any savings that you have outside of a 401(k) or IRA, for example. One advantage of a taxable account is flexibility. Unlike an IRA, which has significant penalties for early withdrawals, a taxable account allows you to access funds at any time. You can also take advantage of tax loss harvesting and low capital gains rates when using tax efficient investments. In addition, investments such as municipal bonds can provide tax-free income.
Review how your money is invested.
How you choose to allocate your assets across different investment types can significantly impact your ability to reach your retirement goals. You have to do some self-assessment to determine what asset allocation works best for your particular situation. Do you want to be an active or passive investor? Do you understand certain investments in stocks? Bonds? Real estate? Investing in what you clearly understand can significantly decrease the risks associated with any type of investment.
Create a plan you can easily follow.
Saving for retirement isn’t a one-time event, it’s a lifelong process of creating good habits. The more you can do to simplify your retirement plan the easier it will be to stay on the right course. It is also important to periodically review your retirement strategies for changes that arise.
What could possibly go wrong?
Expect the unexpected. Since 2009, America has seen a steady growth in the economy, along with an incredible bull market for stock investors. But the 2007-2008 recession and stock market decline were not so long ago. For anyone entering retirement, a financial shock can have a particularly devastating impact. That is why you will need to factor in risk tolerance to your retirement investment plans.
Make risk management a key part of your plan. One assumption is that outside of fixed income investments such as certificates of deposit (CDs) or bank savings accounts, investments in stocks, exchange-traded funds (ETFs), mutual funds, bonds, precious metals like gold, real estate, even cryptocurrencies like Bitcoin will have booms, crashes, ups-and-downs. With stocks and ETFs, typically the longer you hold an investment, the less risky they can be, but no matter what, equity investments go through cycles.
If you make any investment with a long horizon before you retire, you can typically tolerate more risk. By contrast, as you approach retirement, any decline could be swift and dramatic, while recovery could take years. For this reason, you may want to consider adjusting your investments as you approach retirement.
What is the risk of doing nothing? While it may seem that investing in stocks, bonds or other options is too risky, there is an equal risk of missed opportunities. By putting all your retirement funds in CDs, a bank savings account, or cash would seem to have the lowest risk of all. But if you realize a return of 0 to 3 percent as a result, inflation could eat away the value of even a modest investment parked in a “safe” account. If you live on a fixed income, growing inflation can badly eat into your purchasing power and the value of your savings. Be sure to factor this into your retirement savings plan.
That is why it is essential to do your homework. Learn how different types of investments work, their relative risks, and your risk tolerance level. Spend time in the years ahead to learn as much as you can about investing. Taking classes online or at a local college, joining investment groups, or learning through a wealth of excellent books or internet resources can be invaluable to building your wealth. We also recommend partnering with a qualified investment or fee-based financial advisor to help choose the options that are best for you.
Expect much higher healthcare costs. As you age, the cost of healthcare and medicine become a much larger concern. A life-threatening illness, surgery, or chronic condition could quickly drain a substantial part of your savings. This is why consulting with a qualified insurance agent or financial advisor to review options such as long-term care insurance, Medicare Advantage, or Medicare supplement plans is an important consideration as you get older. They can advise you on what insurance does and does not cover so that depending on your health situation, you can plan more effectively.
The road to retirement is long. Don’t go it alone.
So much to do. So much to know. No matter what, don’t shy away from retirement planning and saving. You have spent your life earning a great future, one you richly deserve. Planning for retirement is one of the most important tasks you will face in your life. Take the time to plan, save, and learn. Having the professional help of trusted partners can greatly reduce the risks you face while helping you avoid the significant drain of taxes, inflation, and missed opportunities that could substantially reduce how much you will have when you enter retirement.
Working with a qualified fee-based financial advisor, an investment professional, certified public accountant, insurance agent or broker, banker, and an attorney can do much to help assure your golden years will be all that you dream. The staff at Ross-Stern & Associates are ready to help. Contact or call us at 818.776.0399 to discuss your retirement goals and learn how we can assist you with retirement financial planning and consulting.