These five steps will help you toward a safe, secure, and fun retirement
Retirement planning 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 have saved to allow it to grow.
Last but not least, taxes. If you have received tax deductions for 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.
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.
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- Planning for retirement should include planning your time horizons, planning for expenses, planning for after-tax returns, planning for estate planning, and estimating risk tolerance.
- To take advantage of compounding’s power, plan for retirement as soon possible.
- Investors younger than 50 can take on more risk, but 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.
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.
You also need to have returns that exceed inflation in order to maintain your purchasing power when you retire. Inflation is like an oak tree. It starts out small, but given enough time, can turn into a mighty oak tree,” says by financial planner for retirement.
Hammond says, “We all have heard about compound growth and want it for our money.” Inflation is like compound anti-growth in that it reduces your money’s value. At a mere 3% rate, inflation will reduce your savings’ value by 50% in 24 years. Although it doesn’t seem like much, it can significantly impact your savings if you take enough time.
Your portfolio should focus more on income and capital preservation as you age. This means that your portfolio should be more in bonds and less risky securities. While they won’t provide the same returns as stocks, they will give you income that can be used to live on. Inflation will be less of a concern. An individual who plans to retire next year at 64 is not as concerned about inflation as someone who just joined the workforce.
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 the liquidity requirements to find the best allocation strategy. As your time horizon changes, you should also be rebalancing the portfolio.
Although you might not believe that saving money in your 20s is important, compounding can make it more valuable over time.
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 the mortgage is not paid off or unforeseen medical expenses arise. Sometimes, retirees spend their first year splurging and achieving other bucket-list goals.
“To ensure that retirees have enough savings for retirement, the ratio should be closer than 100%,” states David G. Niggel (CFP, ChFC), AIF founder and CEO of Key Wealth Partners LLC, Litilz, Pa. “The cost to live is rising every year, especially healthcare costs. People live longer and want to be able to enjoy retirement. Retirees will require more income over a longer period of time so they will need save and invest accordingly.
Retirees, who are not required to work eight hours per day, have more time to travel, shop, shop and do other expensive activities. As more people spend in the future, setting realistic retirement spending goals is important.
Your withdrawal rate is one of the most important factors in the longevity of your retirement account. It is important to know what your retirement expenses will be. This will impact how much you can withdraw each year and how your investments are made. You can easily outlive your portfolio if your expenses are understated, while those who overstate their expenses will likely not live up to your expectations. Kevin Michels, CFP and EA, is a financial planner and president of Medicus Wealth Planning, Draper, Utah.
Planning for retirement should also consider your longevity to ensure that you don’t outlive your savings. 2 The average lifespan of people is increasing.
To estimate longevity rates for individuals and couples, actuarial tables can be used (also known as longevity risk).
You might also need to have more money to buy a house or pay for your children’s college education after retirement. These outlays should be included in your overall retirement plan. To ensure that your savings are on track, update your plan at least once per year.
Alex Whitehouse, AIF. CRPC. CWS, President and CEO of Whitehouse Wealth Management, Vancouver, Wash., states that it is possible to improve retirement planning accuracy by estimating and specifying early retirement activities, allowing for unexpected expenses in middle and late retirement, and forecasting what-if-late-retirement medical bills.
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. As you get older, this return threshold decreases 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 can rely on a 12.5% return to make ends meet. The main advantage to planning for retirement early is growing your portfolio and still getting 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.
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 risk-free Treasury bonds that can be used to fund the necessary expenditures?
It is important to be comfortable with your portfolio’s risks and understand what is essential and what is optional. Craig L. Israelsen (Ph.D.), the designer of 7Twelve Portfolio, Springville, Utah, advises that you should not be a micromanager and react to market noise. Overmanaging portfolios is a common mistake made by helicopter investors. If your portfolio has a poor year, you can add money to it. It’s a lot like parenting: The child who needs you the most is the one that deserves it the most. Portfolios are similar. Portfolios are similar. The mutual fund that you are unhappy with may be the best performing next year. Don’t give up on it.
“Markets will experience long cycles of up-and-down and, if your money is invested in money that you won’t touch for 40 years, it’s possible to see your portfolio’s value increase and fall with those cycles,” John R. Frye CFA, cofounder of Crane Asset Management LLC, Beverly Hills, Calif., says, “When the market falls, buy–don’t sell.” Don’t panic. You’d buy shirts if they were 20% off. Stocks would be a better choice if they were 20% off.
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 that particular field. A vital part of a retirement plan is life insurance. A proper estate plan and life insurance coverage ensure 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. Comparing the tax consequences of gifting assets or leaving them to family members and charities is important.
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.