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Updated on Thursday, January 9, 2020
Whether you’re just starting out in your career or are starting to think seriously about planning for your future, our guide to retirement planning covers some of the most common questions that prospective savers face: How much do you need to save? What’s the best way to grow your savings to support yourself once you stop working? Where should you be investing your retirement funds?
We cover these questions and more in our guide to retirement planning below.
What is retirement planning?
Retirement planning is the process by which you prioritize your income and assets to support your ideal lifestyle once you stop working. Retirement planning involves devoting a portion of your paycheck to one or more retirement accounts, such as a 401(k) plan or an individual retirement account (IRA), which can be a traditional or a Roth IRA, among other forms.
Investing early helps you reap the benefits of compounding interest over time. You also need to take into account your risks at various stages of life as you decide how and where to save for retirement.
“Be familiar with all the saving tools and strategies available to you,” said Kevin Gaines, chief investment officer at American Financial Management Group. “Using the ‘best tool’ for a specific need may sound right, but you need to have some flexibility in case things change.”
Retirement planning is an ongoing process, and what works for you now may change over time. Plan to reevaluate your cash flow needs every year and make adjustments to your retirement planning strategy. At some point, you may want to consider the assistance of a certified financial advisor.
How to approach retirement planning
The right strategy for retirement planning will look different for every person or family, but all retirement planning begins with assessing your resources and setting goals.
You begin the retirement planning process by quantifying your resources, said Charles L. Failla, a certified financial planner at Sovereign Financial Group, Inc. How much is your salary? Do you have valuable assets, such as a house? How much money do you have in savings? Getting a full picture of your net worth is the first step.
The next step to approaching retirement planning is to think about what you want your retirement to look like, and how your savings can make those dreams a reality.
“Retirement is not a goal — what you will do during retirement is the goal,” said Gaines. “Your goals create a savings target while you’re working, and then, as you enter retirement, an income target.”
To live comfortably during retirement, you’ll need to save enough to cover at least your basic needs, including housing, transportation, food, medical care, insurance and clothing. Retirement planning can also address what you’d need to do to achieve your ideal retirement lifestyle, whether that includes travel, hobbies or entertainment.
“Beyond goals, other conversations such as long-term care funding and estate planning need to be part of a retirement plan,” said Gaines. “It is very important to understand what could go wrong and how the plan will adjust.”
Online tools, like this retirement income worksheet and this retirement expenses worksheet, can help you estimate your finances during retirement. Understanding this information can help you develop a strategy to withdraw the money you need from your assets while “minimizing the risk of outliving your savings,” added Gaines.
How much should you save for retirement?
Retirement planning gives you a road map to determine how you’ll save enough for your non-working years. However, figuring out the “magic number” can be tricky. Here are two common principles that can help you estimate the amount you’ll need for retirement:
- 4% withdrawal rule: This rule states that retirees can comfortably withdraw 4% of their assets during the first year they stop working. They can then increase the withdrawal amounts to match inflation as the years go on, which should allow their savings to cover them for at least 30 years. Put into action, this rule would allow someone with a $1 million nest egg to withdraw $40,000 in their first year of retirement, with small increases based on inflation in subsequent years.
- 75% of income rule: Another guideline for figuring out your retirement planning goal is planning to spend no more than 75% to 85% of your current income during each year of your retirement. For example, let’s say someone born in 1980 currently earns $100,000 a year and wants to retire at age 67. Under the 75% of income rule, they’d need to have saved nearly $1.6 million by their anticipated retirement age to cover the expenses of their remaining life expectancy of about 21 more years. “Longevity is something else that must be considered — especially if it runs in the family,” added Failla.
What’s the best age to retire?
A 2018 Gallup poll found that the average American expects to retire at age 66. The earliest people can start collecting Social Security is age 62, with full benefits kicking in between age 65 and 67, depending on what year you were born.
While these statistics can serve as a helpful guideline, calculating the right retirement age for you will depend on your individual financial situation. The longer you delay retirement and continue working, the more time you have to build your savings and the higher your Social Security benefits will be (until age 70). Early in your retirement planning, you can assume you’ll retire around age 65 and set your monthly savings goals accordingly. Once you’re in your 50s, reevaluate any potential gaps in your income and set a more specific retirement date to work toward.
Stages of retirement planning
How you approach retirement planning may change throughout your life. Here are some retirement planning tips to consider at different stages.
This is the time to start building good habits: “If you get into the habit of saving now, it will be easier to stick with it in the future,” said Gaines.
Financial advisors encourage young adults to maximize their contributions to retirement accounts to take advantage of compounding interest over the decades ahead. This compound interest calculator will show you how early investing can help your money grow over time.
If your employer offers a match to your 401(k) contributions, make sure you contribute enough to hit the maximum so you’re not leaving money on the table. While young adults who do this will have more time to earn compounding interest on the matching contribution, it’s a smart retirement planning strategy at every stage of life.
If you’re enrolled in a high-deductible health insurance plan, it may be a good idea to open a health savings account (HSA), said Gaines. An HSA can offer tax savings on your contributions, earnings and withdrawals if used for eligible medical expenses. Plus, after age 65, you can spend the money in your HSA on anything you want without paying taxes or incurring any penalties.
Throughout your 30s and 40s, continue to increase the rate at which you save for retirement, Gaines advised. This can be challenging if you’re juggling other major expenses, such as a mortgage, consumer debt and the costs of a growing family.
“Budgeting is critical,” Gaines said. “Hopefully your younger self created a savings discipline that you’re now using [when you have] so many other demands on your money.”
If you find that you’re maxing out your 401(k) or IRA contributions, you may need to start exploring other savings vehicles. A certificate of deposit (CD), brokerage account or automated micro-investing app are all potential places to squirrel away extra money for retirement.
The countdown to retirement is on and, as such, you need to manage the risks of your investments. When you have less than 10 years until your anticipated retirement date, adjust your portfolio to no more than 40% to 50% in stocks, the riskier asset class, said Failla. Allocate no more than 20% of your portfolio to stocks when you’ve got five or fewer years to retirement, eventually bringing it down to a majority of low-risk investments (such as CDs and money market accounts) when you’re in your final year of work, he advised.
You can also start making more precise estimates on your financial goals and retirement expenses during this stage of your life. Eliminate your debt (if you didn’t already do so earlier in your career) and take advantage of catch-up provisions, which allow people to contribute an extra $1,000 to their IRA or an extra $6,500 to their 401(k) each year starting from age 50 in 2020 and 2021.
Retirement accounts you should consider
When it comes to retirement planning, you have a few different options. This article explains the different retirement plans, including 401(k) plans, traditional IRAs, Roth IRAs, SEP IRAs, HSAs and Roth 401(k) plans, along with tips on choosing the right option for you.
While some people may manage their portfolios manually, many others choose to work with a financial advisor who can analyze their individual circumstances and offer advice on where to invest their money for retirement.
You can also open a retirement account managed by a robo-advisor, which uses sophisticated algorithms to invest your retirement savings in diversified portfolios that meet your needs. This could be a more cost-effective option than working with a traditional financial advisor.
Regardless of which option you choose, what’s crucial is to consider what works best for your personal financial situation and to start saving sooner rather than later.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.