Even if you really love your work, there will come a day when it’s time to clock out for the last time and retire. When that time comes, you should have a solid financial plan in place.
How to Plan for Retirement
During your working years, your primary financial goal is to accumulate enough savings to support that plan – to put aside enough money to fund your lifestyle even without a regular paycheck. But accumulating as much wealth as possible is just the beginning: you also need to consider taxes, determine which investments will grow your money best, consider other sources of retirement income and plan for retirement expenses.
Saving money needs to be on your priority list. Most financial pundits agree that you should save at least 10% of your income each year and many suggest increasing that to 20% if you can. However, it’s not just how much you save, but where you save it.
In recent decades, Congress has attempted to incentivize retirement savings by creating special tax-advantaged retirement accounts. The most popular is the 401(K) account offered by most employers, which allows you to make a pre-tax contribution to your retirement savings with each paycheck. Many employers typically offer to match a certain percentage of your contributions, which is essentially free money.
Other retirement accounts can be opened independently of your employer. The most common one is the Individual Retirement Account (IRA). The “traditional” version of these accounts is similar to the 401(K), where the money can be deposited pre-tax; contribute a few thousand dollars to an IRA and the money can be deducted from your taxes. The other variation of the IRA is the Roth IRA, where the money is deposited after taxes – meaning you can’t deduct it from your taxes – but it grows in the account and can be withdrawn tax-free once retired.
Investing Your Savings
It’s not enough to save a bunch of money in a tax-deferred retirement account. To ensure your money grows and multiplies, you should invest it. It’s good to have enough money in checking and savings accounts to cover expenses and emergencies; however, if you save more than that amount, the money loses value – savings accounts don’t offer enough interest to keep up with inflation.
The time-value-of-money concept states that a dollar earned today is worth more than a dollar earned in the future – when that dollar is invested and earn interest. If you have enough to cover emergencies and expenses, you should invest the rest.
So what should you invest in? There is a wealth of information on this topic. One accepted rule of thumb is that your portfolio should consist of 100 minus your age in stocks and the rest in bonds and mutual funds.
Some modern investors believe that this method is outdated and should be replaced with 110 minus your age or higher numbers for those with a higher risk tolerance (the higher the number, the higher the risk). However, this depends entirely on your investment goals, investment strategy and risk tolerance.
Percentages aside, a portfolio consisting mostly of stocks is best when you’re younger because it allows you to offset any losses in the market. As you get older, you should invest a larger portion of your savings in safer investments like metals or bonds so you don’t run the risk of losing a bunch of money in the market just before you retire.
Instead of playing directly with your retirement savings in the stock market, invest the majority of your money in exchange-traded funds, index funds or mutual funds. While fund managers actively manage these funds to “beat the market,” others take a more passive approach. Regardless of which you choose, you can select investments through your 401(k) brokerage firm or provider where you set up your IRA.
Your Retirement Income and Expenses
The money that has saved in your retirement accounts will eventually form the basis of your retirement income; once you reach retirement age, you can begin withdrawing money from those accounts as income.
But IRAs and 401(k)s aren’t the only sources of retirement income. Some people – especially those who work in the public sector – have an annuity or 401(a) plan instead of a 401(k), which provides them with guaranteed income based on years of employment and their prior earnings.
But pensions are becoming increasingly rare. What’s not rare (yet) is Social Security, which provides a regular check from the government; the longer you wait to claim it, the bigger your check will be. Even if it comes from the government, you should know that it is subject to taxation.
Let us know in the comment section how you are saving for retirement.