By Stephen L. Thomas | May 14, 2024 | In
Planning for retirement is a huge undertaking. Creating a plan for how your golden years will pan out requires careful consideration and clear steps. While some enlist the help of a financial professional to get started, others may choose to DIY. While both methods can be effective, the most important thing is getting started. It’s never too early or too late to plan for retirement.
Choose Your Retirement Age
The first step in retirement planning is choosing your retirement age. This is the age that you hope to stop working. As of 2024, the full retirement age is 67 for those born in 1960 and beyond. However, people can begin collecting Social Security benefits at the age of 62. You may choose to retire earlier or later than the Social Security retirement age.
Your retirement age is important because it determines how much you need to save. Your retirement age can also impact the types of accounts and investments you use to save.
Calculate A Retirement Number
To calculate how much money is needed to retire, you start by looking at your current income and expenses. If you hope to maintain a similar lifestyle to your current one during retirement, then aspire to replace 70% to 90% of your annual pre-retirement income. For example, if an individual earns $120,000 per year, they may aim to save 80% of that for annual retirement income, which would be $96,000 per year. You’ll also need to consider inflation and how that will impact the value of your savings.
To calculate your retirement number, multiply your annual budget by 25. To arrive at your annual budget, take your monthly budget and multiply it by twelve. When you have the 25 times number, deduct the savings you’ve already set aside to see how much more you need to save before retirement. Remember that compound interest, when your money earns interest, can help accelerate your savings.
Use a compound interest calculator to understand how much your current savings will be once you reach retirement age. Since money saved for retirement is usually invested, a calculator will help you determine how much your money will grow when you factor in compound interest. A benchmark is usually 6% growth annually, but the percentage varies.
For example, let’s assume you have $20,000 saved now and plan to retire in 30 years. Assuming you didn’t save any more money, and that money grows by 6% annually, in 30 years, you would have about $114,870.
Note that the 25 times number you come up with is just an estimate of what you’ll need and assumes you follow the 4% rule. The rule states you only spend 4% of your savings every year during retirement. That said, there are many factors that are beyond one’s control that could impact retirement savings like health status, market performance, inflation, or living longer than expected and outgrowing your savings. Additionally, you may have access to other forms of income, such as Social Security or rental income, among others.
Set Goals
Once you have a retirement age and number, setting goals is the natural next step. These goals should outline how much you’re going to save, how often and what for. Some goals to help with retirement planning could revolve around how much to save, debt paydown, and how to fund retirement.
Here are some examples of goals related to retirement planning.
- Save $500,000 over the next 25 years for annual living expenses.
- Put away 20% of your income for retirement for the next 30 years.
- Have three sources of income to fund retirement for 30 years post-retirement.
- Pay off mortgage and all high-interest debt before retirement at 65.
Devise An Investing Strategy
An investing strategy comprises how much you’ll save and where. You can save in a range of accounts, with many having tax advantages.
- Workplace retirement plans: 401(k) and 403b accounts are examples of workplace retirement accounts. Some employers provide them to encourage retirement savings. The employer often offers a ‘match’, which is a dollar-for-dollar match to a limit of what the employee contributes to the workplace retirement account. There are also solo 401(k)s for self-employed people.
- Traditional brokerage accounts: While these don’t have tax advantages, you can use them to house retirement savings. The advantage of brokerage accounts is you can withdraw principal and earnings any time you please without incurring penalties, which can be advantageous for people considering early retirement. However, you will owe taxes on earnings from investments.
- IRAs: There are individual retirement accounts that can be used for retirement savings by both formally employed and self-employed people. Some include traditional, Roth, SEP, self-directed, and SIMPLE IRAs. They all have contribution limits and tax advantages, which enable tax-free growth on your money.
People can use multiple types of retirement accounts to help them reach their goals. This can be beneficial since they all have different advantages and can help with tax planning. That said, there are rules around eligibility and contribution limits to be aware of.
Consistency is key in terms of how often you contribute to these accounts so that compound interest has time to grow your money. Automating your investments is a way to avoid forgetting to save or spending your money before you have a chance to.
Update Periodically
Retirement plans can evolve even as life is constantly changing. It is good practice to update your plan as life events occur. For instance, if you develop a health condition later in life, you may need to increase up your savings to pay for healthcare expenses during retirement. Likewise, your retirement savings goals may shift if you grow a lucrative business, get married, or inherit wealth from a family member.
Working with a finance professional to devise a retirement plan can be helpful. If you need help getting started or adjusting an existing plan, someone on our team can help.
