For most, planning for retirement is one of last things on their mind. But the truth is, the sooner a person plans for retirement, the better off they’ll be in the future.
Planning for retirement earlier in life gives you the opportunity to increase your wealth exponentially over the course of your working years.
By understanding how to invest according to your age, your lifestyle goals and the different types of retirement plans, you can get ahead of the curve and plan for a comfortable and fun retirement.
Planning for Retirement According To Your Age
Your current age and projected retirement age define your retirement strategy. The younger you are, the higher level of risk you can afford when creating your retirement portfolio.
If you’re far away from retirement, you can afford higher levels of risk. Retirement portfolios for those looking to retire in 20-30 years can focus on contributing investment capital into stocks. While stocks have high volatility, they also offer the most significant rewards over time when compared with other securities.
Investing in stocks also means countering inflation, which can cost you a lot of money in the long run. Inflation can be especially devastating to individuals who keep their money in savings accounts since they accrue little-to-no interest. Historically, the stock market increases at an average of 7 to 12 percent per year.
If you’re getting close to retirement, your portfolio should be focused on wealth preservation instead of growth. In the event of a market crash, a stable portfolio invested in less-risky assets means you won’t have to hold off on your retirement.
If you’re in between the two extremes, the right blend between stocks, bonds and other investments can prove especially rewarding. Diversification is key to having a well-rounded, secure retirement plan.
What Are Your Life Goals After Retirment?
Regardless of age, your retirement plan needs to take into account your values and the type of life you want to live once you retire. Do you want to travel the world? Travel the country in an RV? Move to Hawaii?
You need to have realistic expectations about your spending habits once you retire. It’s unlikely you’re going to be spending any less during retirement or will want to downgrade your lifestyle. Assume that your spending habits while working will either stay the same or increase when you retire.
A good rule of thumb to determine the amount you’ll need in your retirement portfolio is to take the amount of money you spend while working and divide it by your withdrawal rate. Most financial advisors suggest a withdrawal rate of four percent so that your investments have a chance to grow. For example, if you can live off $60,000/year in retirement, you will need $1,500,000 in your retirement portfolio to retire (60,000 ÷ 4 percent).
When coming up with your target portfolio number, you also need to consider whether or not you’ll be paying taxes on your withdrawals (depending on your retirement plan) and the return you will be getting on your portfolio. If you have a traditional 401(k) or IRA, you will be paying taxes on the amount you withdraw.
Additionally, when you’re nearing retirement age and have shifted your portfolio from mostly stocks to less risky assets, your portfolio growth rate will decrease. This is where the 4-percent rule comes into play – at this point, you may only be seeing 4.5 – 5 percent returns instead of the average 7 percent.
Retirement Plan Basics:
There are many different retirement plans available to investors, most of which are tax-advantaged. These accounts let investors save on paying income taxes either when contributing or when withdrawing from their accounts. In this section, we will cover the most common retirement plans.
401(k), 403(b), and 457(b) Plans
The majority of Fortune 500 companies and many private sector employers offer a 401(k) plan. Other organizations such as public schools offer 403(b) plans, while government jobs provide 457(b) plans. These plans are roughly the same, with few exceptions.
Under these retirement plans, money is automatically deducted from your paycheck and put into the investment plan set by your employer. 401(k)s typically don’t offer individual stock options other than your company’s stock, but often provide a variety of mutual funds.
When selecting a retirement plan, employers will typically set up a 3 percent deposit rate for their employees straight from their paychecks. Financial advisors recommend investing at least 10-15 percent of your paycheck into your retirement plan. Additionally, 401(k)s and 403(b)s often benefit from employer matches or contributions (457(b) plans typically don’t). If your employer matches your deposits or contributes to your retirement plan, take full advantage of it if possible, maxing out your contributions each year.
Unlike the 457(b) plan, 401(k) and 403(b) plans require you to pay the penalty to withdraw money before the age 59 ½ (with some exceptions).
If you’re self-employed and have no employees, you can contribute to a private 401(k) plan and invest a maximum of $57,000 per year.
Traditional and Roth IRA Plans
Another common way to save for retirement is with Individual Retirement Accounts (IRA). With an IRA, you can contribute up to $6,000 per year or $7,000 if you’re over the age of 50.
Traditional IRA plans are available to anyone. Your contributions to your IRA will grow tax-free until the moment you withdraw. These plans are also subject to penalties upon early withdrawal.
Roth IRAs, on the other hand, don’t offer up-front tax breaks. Roth IRAs require investees to pay taxes on contributions up-front. However, once an investor reaches the minimum age threshold, they can withdraw their retirement savings without any penalties or paying taxes.
Roth IRAs also offer more flexibility than traditional IRAs. With a Roth IRA, you can withdraw your contributions at any time without paying the penalty. However, you may be subject to paying taxes on the earnings (the growth of the investment) upon withdrawal.
There are many other retirement plans out there (spousal IRA, rollover IRA, annuities, etc.), but the most crucial part is getting started. So start thinking about your retirement goals, determine how much you’ll need, and start investing!
