A retirement plan involves many steps that change over time. You need to create the financial cushion necessary to fund a comfortable, secure, and enjoyable retirement. It’s the fun part that makes it worthwhile to pay attention to what is important, and perhaps even boring: how you will get there.
Planning for retirement starts with determining your retirement goals and the time it will take to achieve them. Next, you will need to consider the different types of retirement accounts that you can use to help you save money for your future. You must invest the money you save to allow it to grow.
Last but not least, taxes. If you have received tax deductions for the money you have contributed over the years to retirement accounts, you will be subject to a large tax bill when you withdraw those savings. There are many ways to reduce the retirement tax impact while saving for the future and to continue the savings process once you retire. Use a paycheck calculator to see the impact of your take-home salary and make a retirement savings plan.
These issues will be discussed in detail. First, let’s look at the five steps everyone should follow, regardless of their age, in order to create a solid retirement plan.
KEY TAKEAWAYS
Planning for retirement should include planning your time horizons, planning for expenses, planning for after-tax returns, planning for estate planning, and assessing your risk tolerance.
To take advantage of the power and potential of compounding, it is important to plan for retirement as soon as possible.
Younger investors are more likely to take on more risk, while those closer to retirement need to be more cautious.
As retirement plans change over time, portfolios need to be rebalanced as well as estate plans updated as necessary.
1. Understanding Your Time Horizon
The foundation for a successful retirement strategy is your current age and the expected retirement age. Your portfolio is more vulnerable to risk the longer you wait before retiring. You should invest the majority of your assets, including stocks if you are young and have a 30-plus year retirement date.
Stocks will experience volatility but have historically outperformed bonds and other securities over longer periods of time. This is the main idea of “long”, which means at least 10 years.
Your retirement plan should be broken down into several components. Let’s suppose a parent wants a two-year retirement, to pay for their child’s college education at 18, and to move to Florida. The retirement plan would have three phases.
There are two years before retirement (contributions remain in the plan), saving for retirement and paying college. Finally, there is the possibility of regular withdrawals to pay living expenses. Multistage retirement plans must consider different time frames and liquidity requirements to find the best allocation strategy. As your time horizon changes, you should also be rebalancing the portfolio.
2. Calculate your retirement spending needs
You can define your retirement portfolio by setting realistic expectations regarding post-retirement spending habits. Many people assume that their annual spending will be 70% to 80% after retirement. This is especially true if there are unforeseen medical costs or the mortgage has not been paid. Sometimes, retirees spend their first year splurging and achieving other bucket-list goals.
3. Calculate the After-Tax Rate for Investment Returns
After determining the spending and time horizons, calculate the after-tax real return to determine if the portfolio can produce the required income. For long-term investments, a required rate of return that exceeds 10% is not realistic. This return threshold decreases as you get older since low-risk retirement portfolios are mostly composed of fixed-income securities with low yields.
For example, let’s say a person has a retirement account worth $400,000 with $50,000 income requirements. Assuming no taxes and preservation of the portfolio balance they are relying upon a 12.5% return to make ends meet. The main advantage to planning for retirement early is the ability to grow your portfolio and still get a reasonable rate of return. The expected return on a $1 million gross retirement investment account would be much lower at 5%.
Investment returns can be taxed depending on which retirement account you have. The actual rate of return must therefore be calculated after tax. It is important to determine your tax status before you withdraw funds.
4. Compare Investment Goals vs. Risk Tolerance
A proper portfolio allocation is essential in retirement planning. It doesn’t matter if you are the one making the investment decisions. What level of risk will you take to achieve your goals? Are there any Treasury bonds that are risk-free and can be used to fund the necessary expenditures?
5. Keep on top of estate planning
Another important step in a comprehensive retirement plan is estate planning. Each aspect of the plan requires the expertise and knowledge of professionals such as accountants and lawyers in the field. A vital part of a retirement plan is life insurance.
A proper estate plan, along with life insurance coverage, ensures that your assets will be distributed in the way you choose and that your loved ones won’t experience financial hardship after your death. A well-planned plan can help you avoid a costly and lengthy probate process.
Another important part of estate planning is tax planning. It is important to compare the tax consequences of gifting assets or leaving them to loved ones or charities if an individual wish to leave assets.
Common retirement plan investment strategies are based on producing returns that can meet annual inflation-adjusted daily living expenses while maintaining the portfolio’s value. The deceased’s beneficiaries receive the portfolio. To determine the best plan for you, consult a tax advisor.
