Admit it, you do not spend enough time preparing for retirement. Hopefully you are not like some people thinking that you are going to win the lottery and that is how you will retire. Well, whatever the case. This Definitive Guide to Retirement: A Five Step (Easy) Guide will at least offer some clues on what you should do to prepare for retirement. Face it, retirement is a long vacation and you plan time preparing for vacation. In that case, time to get prepared for your long vacation - retirement.
If time is money, how many years do you have in the bank? We are living longer, healthier lives. As a result, retirement, for many, may last twenty years or more. Inflation will most likely decrease the purchasing power of your money, which means that during your retirement your dollars may buy less than they do today. For example, at 3.5% inflation, $100 today would be worth only $42.31 in 25 years, and would be further reduced to $30.00 in 35 years.
The sooner you start building your nest egg, the longer it has to grow. Consider the following examples that assume no taxes or inflation. Suppose at age 25 you save $100 per month for twenty years and earn 6% interest. If you make no additional contributions after the age of 45 and your savings continue to earn 6% interest, at age 65 your savings will be worth $148,182. However, if you begin at age 45, save $100 per month for twenty years and earn 6% interest, at age 65 your savings will be worth only $46,204. In order to achieve savings of $148,182 over twenty years, you would need to earn interest at a rate of approximately 15% per year or save significantly more money per month!
While both scenarios illustrate the same amount of money being saved, the additional twenty years and the compound interest factor make all the difference in the world. If you are in your prime earning years and start setting money aside now, you have a better opportunity to save for the retirement you desire.
- Identify Your Goals
The first step in developing a savings strategy that best meets your retirement needs is determining your objectives. How do you envision your “golden years”? Spend some time thinking about what is really important to you. Allow yourself to dream about what you want your future to look like. Thinking about it early puts time on your side. At what age do you want to retire? Where do you see yourself living? Do you enjoy traveling? Would you like to continue to work at least part-time? Are you imagining yourself playing golf every day? These questions and others will help you shape a vision for your retirement.
Once you have a sense of your objectives, it’s time to estimate your financial needs. A good rule of thumb is that a person’s living expenses in retirement will be roughly 30% less than his or her current expenses. While some costs may increase, such as health care and leisure activities, others most likely may decrease. For example, retirees tend to spend less on mortgages and education.
- Know Your Resources
The second step in planning is determining where your retirement money will come from. Most people draw on three main sources of income during retirement—Social Security, employer-sponsored plans, and personal retirement savings. Each offers important resources that will add to your overall retirement plan. You have a great deal of control as to how much money you can accumulate. The choices you make today will invariably influence your financial security in your later years.
Social Security offers a retirement benefit to workers and their spouses. You can start receiving benefits as early as age 62 (considered early retirement), or wait until you reach full retirement age of 66 to 67 (depending upon your year of birth). The benefits you receive are based on the income you have earned over the course of your life, subject to a maximum amount. You can find out how much you can expect to receive by contacting the Social Security Administration (SSA) or visiting their website at www.ssa.gov.
For most people, Social Security provides only a base level of income. The maximum annual benefit for a person who retires in 2015 at the age of 66 is $31,956; the benefit for a non-working spouse is only 50% of that amount. These benefits will most likely not meet all of your retirement needs. Most people opt for a well-rounded plan that includes additional sources of income.
Employer-sponsored plans are a staple of retirement income for most individuals. Many employers offer benefit packages that include retirement savings options, such as pension plans (defined benefit, defined contribution, or profit-sharing), 401(k) plans, 403(b) plans (for nonprofit organizations), Simplified Employee Pensions (SEPs), and Savings Incentive Match Plans for Employees (SIMPLEs). Here’s how the plans work:
A pension plan is designed to provide an employee with retirement income. Benefits are generally based on a variety of factors, including salary, length of service, and a benefit formula that averages the employee’s earnings over a prescribed period of years. In some instances, an employee may make additional contributions. To receive benefits, you generally must wait to reach the normal retirement age (NRA), typically age 65 to 67, and be employed for a certain number of years. Upon retiring, you may have options as to how and when you collect your benefits, such as in monthly payments, or in one lump sum. The prevalence of pension plans has decreased with the rise in popularity of the 401(k) plan.
A 401(k) plan, offered by many private employers, provides you with the opportunity to contribute part of your salary, with restrictions, into a retirement fund. Your employer may match your contributions, up to a predetermined percentage and subject to a maximum. For example, if your employer matches your contributions by 50%, for every dollar you put into the fund, your employer will add $.50. Your contributions are pre-tax, so you defer any payment of taxes until you begin taking withdrawals. If you withdraw money from your 401(k) before the age of 591⁄2, you will incur a 10% income tax penalty, except under certain circumstances (such as hardship, purchase of your first home, or educational expenses).
A 403(b) plan is similar to a 401(k) plan, but is designed for employees of certain educational and nonprofit, or exempt, organizations. You can contribute part of your salary, with restrictions, to a tax-deferred annuity. Your deposits earn interest, and you are not taxed until you begin receiving payments, but the taxes you pay are based on annuity distribution rules. Because exempt employers do not receive the same tax deductions as profit-making businesses, matching plans are less common.
SEPs are a common option for small businesses with 100 or fewer employees. In SEPs, employers make use of Individual Retirement Accounts (IRAs) as a simplified way of providing their employees with a pension benefit. The contributions are not considered part of your gross income, and you don’t pay taxes until you make withdrawals.
SIMPLE plans utilize either IRAs or 401(k) plans; they are also tax-advantaged and used by small businesses with 100 or fewer employees. Subject to restrictions, your employer may choose to match your contributions up to a certain percentage of your salary, or may choose not to match, but rather to make contributions on behalf of all eligible employees, based on a percentage of salary. Again, your contributions are pre-tax, and you defer payment of taxes until you begin taking withdrawals.
Because retirement savings options are often unique to the employer, it is important for you to understand the specifics of your company’s benefits package. Contact your employer’s benefits coordinator for more information. The tax advantages and matching contributions make employer-sponsored plans the most popular retirement savings vehicles.
Personal retirement savings may be the key to achieving your financial goals. Common complements to Social Security and employer-sponsored plans include the following.
Traditional IRAs allow you to set money aside in a tax-deferred account. Depending on your income and whether or not you participate in an employer-sponsored retirement plan, you may be eligible to take an income tax deduction. The maximum deduction is dictated by the IRS every year. If you are age 50 or older, you may be entitled to additional “catch-up” contributions. Even if you don’t qualify for the deduction, your contributions may earn interest tax free; you pay taxes upon withdrawal, avoiding penalties if you do so after the age of 59 1⁄2.
Roth IRAs are tax free upon withdrawal, but your initial contributions are not tax deductible. The contribution limitations are the same as with traditional IRAs, including the guidelines for “catch-up” contributions, and you pay no penalties if you make withdrawals after the age of 59½.
oInvestments such as annuities, mutual funds, stocks, bonds, traditional savings accounts, and certificates of deposit (CDs) can diversify your retirement savings portfolio. Certain vehicles are more at risk to market fluctuations than others.
- Make a Plan
Now that you’ve thought about your retirement objectives and your potential sources of income, the last step is developing a plan that works for you.
Analyze your present spending habits to find out where your money is actually going, and how much you have available to put aside for retirement savings. If you’re like most people, you probably could save more money. It may be worthwhile to investigate ways in which you can adjust your lifestyle to decrease spending, and thus increase the amount available for savings. Can you “nip and tuck” without detracting from your quality of life? Are there short-term sacrifices you are willing to make for long-term gain?
As you look at your savings and potential sources of income during retirement, assess your risk profile and risk tolerance level. Are you uncomfortable risking any of your principal? Do you want to opt for growth-oriented investments that are more vulnerable to market fluctuations? Or, would you prefer to keep your savings in a traditional fixed interest savings plan?
- Invest!
Stick to your plan, but monitor it regularly. Make sure your disciplined approach to saving continues to meet your current needs and your future retirement goals.
- Seek Professional Advice or Read Up
A financial professional can help tailor a plan that’s right for you. It’s never too late to start saving, and the sooner the better. Get referrals, do your research finding the right financial coach, or in any event, seek assistance in some way. Heck, even the best golfers in the world have coaches.
Lastly, go it alone. Yes, if you have the time to allocate to such activities, research the capital markets, economic philosophies, etc to prepare yourself for retirement. Then again, the thought of saving money and going it alone is great but most people do not want to spend the badly needed time going it alone.
There you have it, The Definitive Guide to Retirement: A Five Step (Easy) Guide.
We welcome your questions! You can reach us by phone at (888) 808-8278 or by email at info@vastsolutionsgroup.com.
Kenner French is an author, keynote speaker, and is with VastSolutionsGroup.com - the pioneer in tax and retirement strategies for entrepreneurs using AI.
