What to Consider When Planning for Retirement
Everyone dreams of a comfortable retirement where they can enjoy life’s simple things. Part of making that dream a reality is planning financially for this stage of life.
Financial security in retirement is the best gift you can give yourself. If you’re wondering how to start planning for retirement, this guide can help.
Understanding the Importance of Starting Retirement Planning Early
Investing in your retirement early will help you feel more secure in your future and let you enjoy the fruits of your labor later in life. The earlier you start, the more time you have for your investments to grow. Due to compound interest, your retirement funds can increase by thousands yearly. Saving a small amount earlier can grow to much more than saving a larger amount later.
Another benefit of having time on your side is that you can take more risks in your investment choices. When you are younger, you can choose investments that carry a higher level of risk but might mean higher potential returns. If there are losses, you have time to bounce back. When you are older, safer investments with lower returns are likely the way to go.
Estimating the Amount of Money Needed for Retirement
Many experts recommend planning to spend 70% – 90% of your existing annual income every year of retirement if you want to maintain your pre-retirement lifestyle after you retire. This percentage is known as the replacement ratio.
The replacement ratio assumes you will need less money to maintain your lifestyle once you retire because you will have paid off significant debts, such as a mortgage, and will no longer have dependents to support. While this ratio is not a one-size-fits-all formula, it does make it easy to calculate your costs, adjust your lifestyle if necessary, and calculate a goal to work towards.
Understanding Your Investment Options
Retirement Accounts and Contributions
Part of the retirement planning process involves contributing funds to specified retirement accounts. Most people use their retirement funds to purchase investments, which typically have a higher rate of return than a regular savings account.
There are different kinds of retirement contribution accounts. The following are the most popular options:
• 401(k): With this employer-sponsored plan, you can have a portion of your pre-tax income deducted automatically and placed in this account. Many employers match the amount you elect to deduct, up to a certain percentage.
• Roth IRA: An individual retirement account (IRA) enables you to save for your retirement in a tax-advantaged retirement account by contributing after-tax dollars. Once you retire, you won’t have to pay income taxes on qualified withdrawals.
• Traditional IRA: With a traditional IRA, you contribute pre-tax dollars, reducing your taxable income for the year you contribute. However, you will pay income tax on withdrawals you make.
Please note: With few exceptions, there are significant tax penalties for early withdraw on many retirement accounts. These penalties are designed to encourage long-term investing and deter you from withdrawing money from your accounts before retirement. Check the terms and conditions on your retirement plan for more information.
Understanding Different Types of Investments
Stocks, bonds, and mutual funds are popular investment options.
• Stocks allow you to buy a portion of a company.
• Bonds enable you to invest money by loaning it to a borrower, usually the government or a company.
• Mutual Funds enable you to pool money with other investors to buy bonds, stocks or other investments together.
Investment Characteristics to Consider
Investments are commonly measured by three characteristics: yield, liquidity, and security. Each investment you make will have a combination of these three characteristics.
• Yield: This refers to the overall return you expect to receive from an investment. Some investments such as bonds will have a fixed yield for the duration of the investment term. The yield for other investments such as stocks will vary depending on variables like market value fluctuations or dividends.
• Liquidity: This refers to how easily or quickly you can sell your investment and turn it into cash. Typically, investments such as bonds lock your money in for a set term and have limitations or steep penalties for early withdraw. Other investments such as stocks do not restrict when you are able to sell.
• Security: Security measures how well your investment is protected against fluctuations in the economy, good or bad. Bonds are usually considered investments with a high level of security since the most common bonds are issued and insured by the U.S. government.
These three investment characteristics typically have an inverse relationship. As a rule of thumb, investments that offer a high yield of return usually carry a higher risk and less overall security. As an example, stocks traditionally fall into this category as market volatility can make stock values surge or plumet based on multiple economic factors.
A good way to balance anticipated yield and security for investments is through the risk/reward ratio. This ratio compares the expected return with the level of risk you will carry to see the return. The higher the risk, the higher the potential reward.
There is no set rule for the risk/reward ratio, but most market strategists recommend a 1:3 ratio, which generally means that to earn $3, you have to invest or risk $1. The ratio can help you better manage your contributions and understand your risk of loss.
Regularly Reviewing and Adjusting Your Retirement Plan
Since investments can be volatile, you need to adjust your portfolio occasionally to ensure that you are well-equipped for the future and on-track to meet your retirement goals. Rebalancing your portfolio offers several opportunities.
As you get closer to retirement and want to safeguard your investments against market fluctuations, moving more of your assets into high-security, low-yield options may be the best fit for you.
Alternatively, if you are not satisfied at the rate in which your investments have been growing, allocating a larger percentage of your portfolio into investments that offer a higher potential yield may be an attractive option. A certified financial planner can help you assess your current retirement assets and help ensure that you are on track to achieving your goals.
How to Handle Retirement Planning If You’re Starting Late
The best time to start retirement planning is now. First, estimate what you will need to cover your expenses when you retire. It might be easier to gauge this realistically if you are starting late.
Consider your savings options with a 401(k), Roth IRA or traditional IRA. Once you have decided on the best option, it is time to develop strategies to maximize contributions. For IRAs, the contribution limit for 2024 is $7,000. However, if you are 50 or older, you can make a catch-up contribution of $1,000 for $8,000 total. For 401(k)s, the contribution limits vary based on your account type. As with IRAs, if you are older than 50, you may make additional catch-up contributions to your 401(k).
You may need to cut costs or delay retirement so you can live comfortably later. Most people can begin claiming Social Security benefits at age 62, but your benefits will be reduced. The longer you wait, the more you’ll receive.
Sources:
Linked:
https://www.cnbc.com/guide/retirement-planning/#how-much-do-you-need-to-save-for-retirement
https://www.investopedia.com/terms/r/retirement-contribution.asp
https://www.investopedia.com/terms/r/riskrewardratio.asp
https://www.investopedia.com/terms/i/investing.asp
https://www.investopedia.com/terms/b/balancedinvestmentstrategy.asp
https://www.investopedia.com/investing/how-renew-and-adjust-your-portfolio/
https://www.ssa.gov/benefits/retirement/planner/ageincrease.html
https://midpennbank.com/trust-wealth-management/
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Disclosures
The material on this site was created for educational purposes. It is not intended to be and should not be treated as legal, tax, investment, accounting, or other professional advice.
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