Everyone wants to have a comfortable and enjoyable retirement, but without adequate planning it probably won't happen. People are living longer than ever, which is obviously good news, but that means retirement is becoming more expensive. Some people believe that they can count on Social Security and don't need to plan on their own, but this is a dangerous strategy, as it will cover only a fraction of a typical retiree's expenses, and the long-term health of the Social Security system is very much in doubt. This section is designed to teach you what you need to know to make your golden years everything you want them to be.
|The first step in retirement planning is estimating how much money you'll need. A popular rule-of-thumb claims that you will only need about 70% of your pre-retirement income to maintain your lifestyle in retirement. While you will probably save some money currently being spent on work-related items (such as formal clothes and commuting), other costs go up in retirement (health care, hobbies, etc). 70% may be a useful rule of thumb, but some people find 50% is plenty while others feel they need 100%. Some of the sites we link to provide more accurate estimates based on your specific circumstances.
|The second step in retirement planning is figuring out where the money you're going to need will come from. Visit the Social Security Administration site to get an estimate of how much you'll receive, and add to this any pension you'll be receiving from your employer. Unfortunately, traditional pensions and Social Security together probably won't come close to providing you with what you'll need. In addition, unless you're nearing retirement, you shouldn't count on ever seeing any of the money you've been paying into Social Security, because the future of the system is very much in doubt.
|This is why it's so important to take your financial matters into your own hands. If you have a 401(k) program at work (or a 403(b) or 457), it's usually wise to contribute as much as you can. This is even more true if your employer provides some matching of your contributions. If you have no retirement plan at work, contribute to a traditional IRA or a Roth IRA. Your contributions to your 401(k) or IRA are tax-deferred, so that you don't pay any income taxes on your contributions until the money is withdrawn (usually in retirement, when your tax bracket will probably be lower).
Since tax laws are always changing and your retirement may be many years away, you should also start saving and investing on your own, outside your tax-deferred plan.
Here are some more tips on retirement planning:
# Nowadays, people are living longer so retirees are spending 30 years or more in retirement. It is important to plan ahead if you want to maintain your standard of living during that time. Investing in tax-deferred savings plans and investing in other sources can help you get to a comfortable level for retirement. Determine your current situation. Obtain the current value of regular accounts, IRAs, and company tax-deferred savings plans. Get an estimate of any company pension plan. Estimate your future Social Security benefits. This can be done more easily with a retirement calculator.
# Choose a retirement date.
# No matter how young or old you are, get started today. Due to the miracle of compounding, starting a little earlier makes a big difference. Consider the following (assuming a 10% annual return): Who do you think would have more money in 40 years, a person who contributes a fixed amount every year for the first 8 years and then does nothing for 32 years, or the person who does nothing for the first 8 years and then contributes that same amount every year for the next 32 years? Believe it or not, the first person would be ahead at the end. Get started today!
# Although it might sound grim, it's helpful to calculate your expected longevity in order to estimate how many years you'll need to have retirement income for. The further away your retirement is, the more risks you should be willing to take in pursuit of higher returns. In general, this means investing in stocks (and stock mutual funds) when retirement is far away, and a mix of stocks and bonds as retirement approaches. Whenever possible, it usually makes sense for the bond investments to be in a tax-deferred account, so that you can avoid paying taxes on the interest earned until you withdraw the income during retirement.
# Make maximum contributions to your 401(k). Benefits include the tax deduction, matching contributions by some employers, and tax-deferred growth on earnings in those accounts. IRAs can be another good retirement plan option. We will explain the difference between traditional deductible, non-deductible, and Roth IRAs. Only make withdrawals in emergencies; first consider taking money out from taxable accounts so that the tax-deferred accounts can keep compounding overtime.
# Estimate the average inflation rate for the rest of your lifetime.
# You may have found that you'll have plenty of money in retirement. Congratulations. More likely, the amount was less than you would like, as it is for most people. But it's not too late to do something about it, and the sooner you act, the more you can improve the situation. Learn about the various retirement plan types described in the following section, see if any are right for you, and get started right away. You will find out that you can take advantage of tax-deferral plans, which basically allow you to avoid paying taxes until withdrawal at retirement; you will learn about the benefits of compounding that some plans give with tax-deferral benefits too.
|Investing shouldn't stop when retirement starts. Even if you are already retired, you've probably got many years ahead of you; most people will have 15-20 years of retirement, and this number keeps increasing. Don't immediately shift all your money into fixed-income and money market investments. You should still be planning relatively long term, probably a mix of growth and income. We encourage you to check out the links above, but you should also consult a professional to discuss your unique situation. If you don't meet your retirement goals, there are still some options. Determine the average rate of return on your investments before and after retirement. Stocks have a good track record for long-term growth, so invest a portion of your money in stocks that will grow your savings faster than inflation.
|Withdrawing your money in a tax-efficient way can make it last longer - for example, withdraw from taxable accounts first so that savings in tax-deferred plans can continue to compound tax-free. The IRS does have minimum distribution rules, so you might want to consult a tax professional or financial advisor for advice. If you have paid off most or the entire mortgage on your home, you can transform your home equity into cash through a reverse mortgage. Check out the National Center for Home Equity Conversion site for more information.
|There are other things you can do as well.
1. Determine your tolerance for risk to define the right mix of stocks and bonds for your portfolio. Experts mention a good starting point for people 20 years or more away from retirement to have a mix of 70% invested in stocks and 30% in bonds. Consider investing more aggressively if retirement is sufficiently far away ( Investing Basics). As mentioned before, the power of compounding can make a big difference; a slight increase in return can make a big difference in the long run. As retirement approaches, you can move gradually away from stocks and toward bonds, but you shouldn't have 100% bonds as soon as you retire, because you'll still have a lot of years ahead of you and should keep a mix of stocks and bonds.
2. Consider tightening your budget ( Budgeting).
3. Consider working a little longer than your desired retirement date, even part-time employment can help you stay mentally as well as fiscally fit.
4. Consider relocating to an area with a lower cost of living. Some of the sites we link to in our Home Buying section can help you compare the costs of living in different cities ( Buying a Home).
Once you are in retirement, you do not have to stop investing and planning. There are still many actions that you can take even while in retirement to plan for your financial future.
|Apply for Social Security benefits at least three months before your retirement date. Together with the Social Security application, you can also select a Medicare plan.
|Do not invest solely in bonds; continue having a mix of stocks and bonds in your portfolio. Keeping money in stocks will protect you against inflation. Consult with a financial advisor before withdrawing funds; if you have a Roth IRA it is better to use these funds first since they are not taxed, then you can use funds in regular brokerage accounts that are subject to long-term capital gains only. Make sure you start IRA withdrawals after age 59 1/2 but before 70 1/2, because the IRS will charge 50% of the amount that was not withdrawn by that time.
|Leave a power of attorney for your spouse or children to make financial decisions for you. If you own a home you can move to a less expensive place after retirement or start taking a reverse mortgage to receive monthly income. If you are over 75 and expect to have more than the maximum estate-tax exemption, which is $1,000,000 in 2003 and 1,500,000 in 2004 and 2005, you might want to make family gifts of up to $11,000 per person to reduce your estate. Also, make charitable donations to reduce your taxable income.
Two important considerations are your Estate Planning and how you allocate your assets ( Estate Planning). For more on these two subjects, click on the links.
|When considering retirement plans, it is important to decide how assets should be allocated across accounts and investment types depending on your age. Asset allocation refers to the primary sources of investments in a portfolio: stocks, bonds, cash. Since the three markets do not move in the same direction, when one is high another is low and so on. Consider having your money spread in these three areas to minimize the risk and protect the asset growth.
You can use retirement calculators to determine how much you will need in retirement. There are important things to consider, first your required annual income, the expected inflation rate, your life expectancy, and your expected annual return on investment.
Ages 20-49 are considered the Accumulation years, Ages 50-59 are considered Transition years, Ages 60-74 are the Early Retirement Years, and above 75 is considered the Late Retirement years. Experts recommend a breakdown between stocks and bonds according to age.