Retirement planning is a combination of cash flow planning, income tax planning, investment planning, estate planning, distribution planning and lifestyle planning. In other words, you need to have a plan to retire, no matter your circumstances.
The Balance.com, a website dedicated to personal finance, offers the following key takeaways on its “How to Plan for Retirement” page:
- Save as much money as you can.
The bad news here is that 20 percent of Americans aren’t saving at all, while more than a one quarter of Americans have less than $1,000 in their savings account, according to a Bankrate study reported on The Balance personal finance website. Experts suggest a savings rate of about 10 percent of your disposable income. Among Americans who save, however, most save just five percent of their disposable income.
Money market accounts and CDs (Certificates of Deposit) are good ways to save, and both typically offer higher interest rates than savings accounts. You must keep your CDs in the bank for an extended period, however, and time commitments vary. In addition, you may have to pay a penalty if you take out your money early.
- Put your money in tax-advantaged retirement accounts.
Traditional individual retirement accounts (IRAs) and 401(k) plans are examples of tax-deferred accounts in which earnings on investments are not taxed every year. Instead, tax is deferred until the individual retires, at which point he or she can start making withdrawals from the account.
Tax-exempt accounts, on the other hand, don't deliver a tax benefit when you contribute to them. Instead, they provide a future tax benefit since withdrawals at retirement are not subject to taxes. Roth IRAs and Roth 401(k)s are types of tax-exempt accounts.
- Invest your money in the markets, adjusting your asset allocation as you get older.
While a regular investment account doesn’t have the tax advantages of tax-deferred or tax-exempt accounts, as
CNN Money points out, there are limits on how much money you can put into them each year. Not so with private
CNN’s experts advise a mix of stocks and bonds.
Your bank may provide a free “retirement calculator” to help you figure how much money you will have available at retirement. (Click here to view Charlotte State Bank & Trust’s retirement planner.)
Where’s My Pension?
The average retirement age in the United States, according to U.S. Census Bureau data, is 63 for women and 65 for men. While you may not actually retire until your late 60s or 70s, you should start thinking about it as soon as you start working. Some experts suggest you start saving in your 20s, when you begin earning paychecks, because the sooner you begin saving, the more time your money has to grow.
And make no mistake: The person most responsible for your retirement is you. Gone are the days when people worked for the same company their entire careers and received a pension and/or a generous retirement package that included a comfortable income and health insurance for the rest of their lives.
Back in the day, most Americans could also count on steady income from Social Security every month, as well as comprehensive health benefits through Medicare. These two ongoing government programs, so vital to seniors, seem under constant attack.
Social Security and Medicare are hanging in there, for now, but relying on them solely for your retirement might prove insufficient. In fact, the greater your pre-retirement earnings, the less you should count on Social Security, which favors lower wage earners. If you do have a pension and substantial income-producing assets, there is a strong possibility that 50-85 percent of your Social Security benefits will be taxed.
How did we arrive at this situation? Over the last 30 years or so, a dramatic shift occurred among most employers away from what are called “defined benefit plans,” or traditional pensions, which were funded by employers. Replacing the pensions were “defined contribution plans” funded by employees from their earnings and from investments made by the plan provider. In some cases, such plans are bolstered by matching contributions from employers.
As the U.S. Department of Labor points out, a defined contribution plan does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee’s individual account under the plan, sometimes at a set rate, such as five percent of earnings annually.
These contributions generally are invested on the employee's behalf. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.
The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans. This law covers defined benefit plans and defined contribution plans.
Social Security is a defined benefit plan, while 401(k)s are defined contribution plans.
“Not only has the guaranteed security of pensions been attacked, but I fear that we’ve hit a critical point of no return,” writes G.E. Miller on 20SomethingFinance.com. “401(k)s are now so ingrained in our culture that pensions are viewed as a Jurassic, boring old benefit of yesteryear.”
(The website conducted a poll asking readers if they would rather have a defined benefit pension or a defined contribution 401(k). No surprise; 83 percent picked the pension.)
Barring another time-travel miracle from John Hammond and the folks at InGen, who brought back the dinosaurs, pensions aren’t coming back, so what do you need to do to prepare for retirement? Keep in mind that getting ready to retire is a process. Investopedia.com says retirement isn’t just one phase of life, but a succession of phases with different spending priorities and budgeting needs. That website divides the phases into Pre-retirement (age 50 to 62), Early Retirement (62 to 70), Middle Retirement (ages 70 to 80) and Late Retirement (80 and up).
Money isn’t everything?
As retirement approaches, experts say, maximize your income by eliminating unnecessary expenses. Carefully review how you spend your money and see if you can reduce or cut certain expenses.
The Simple Dollar, a personal finance website, lists 40 ways to save money on monthly expenses, including debt consolidation, refinancing your home and/or your car, reducing restaurant dining and carryout, etc.
In the AARP’s “Five Secrets to a Happy Retirement,” Secret No 1 is “money isn’t everything.” Solid counterarguments notwithstanding, remember that in retirement, you won’t be commuting to work, paying payroll taxes toward Social Security and Medicare, or putting a chunk of every paycheck into a retirement account. According to AARP, most planners say that 80 to 85 percent of your preretirement income is plenty. And if you’ve paid off your mortgage, you may need even less than 80 percent.
The bottom line: If you want to have enough money in retirement, says AARP, make sure your lifestyle matches your budget. Determine what sources of income you will be able to rely on during retirement and how much income you will need. Your sources may include:
Personal savings. A MagnifyMoney survey of over 2,000 Americans reveals a staggering statistic: More than 1 in 4 Americans don’t even have $1,000 saved up. Even worse, 20 percent of Americans aren’t saving at all.
It's important to have an emergency fund set aside to cover unexpected expenses, but Bankrate’s January Financial Security Index found that fewer than 4 in 10 U.S. adults could absorb the cost of a four-figure car repair or emergency room visit by tapping into savings.
Social Security. Determine what percentage of your pre-retirement income will be replaced by Social Security benefits. Does it make sense for you to start collecting benefits sooner rather than later?
Retirement savings plans. These defined contribution plans, as noted earlier, depend mostly on employee, rather than employer, contributions, and are dependent on investment performance.
Fortunately, the federal government has taken steps to make it not only easy to save and invest for retirement, but also to provide generous tax breaks for doing so. This started with the introduction of IRAs in 1975 as the first government-sponsored, tax-advantaged tool to help Americans save for retirement.
For anyone saving for retirement with a traditional or Roth IRA, Kiplinger reports, the 2021 limit on annual contributions to their IRA account is $6,000, the same as it was for 2019 and 2020. The additional IRA “catch-up” contribution for people 50 and over is not subject to an annual cost-of-living adjustment and stays at $1,000, too (for a total contribution limit of $7,000 for IRA savers age 50 and older).
For 2021, employees who are saving for retirement through 401(k)s, 403(b)s, most 457 plans, and the federal government's Thrift Savings Plan can contribute up to $19,500 to those plans during the year. That’s the same contribution limit in place for 2020.
The “catch-up” contribution limit for employees age 50 or older who participate in these plans also holds steady in 2021 at $6,500 (for a total contribution limit of $26,000 for employees 50 and older).
A well-diversified retirement plan may include multiple retirement savings vehicles. It’s important to remember that with a tax-deferred savings plan, you may be responsible for making the investment choices that affect your account’s long-term performance. You need to understand each of the available investment options, how they work, and which ones are most suitable for you.
Growth should still be a part of your investment portfolio. Keeping all your financial assets in purely income-producing savings or investments may unnecessarily limit their potential for growth.
Lifestyle. Will your savings be sufficient, or will you have to consider altering your lifestyle? You may need to work part-time even if you don’t want to.
Experts advise planning to live a long time, to at least age 85. And don’t think your living expenses will be significantly lower after you retire. You won’t have commuting and other employment expenses, but you should determine what other costs you may voluntarily reduce or eliminate.
Living arrangements. If you’re a homeowner, you’ll need to factor in mortgage, upkeep and related expenses into your retirement planning. You might consider selling your home and moving into a smaller residence.
Why decide now? The key is to start planning before you retire. The worst time to make a decision is when you’re forced to make one. Having a general idea of where you'd like to live allows you to make the appropriate changes in your retirement strategy. If you can, and conditions are right, consider buying property prior to retiring. You may have a better chance of securing a mortgage if you’re still working and your income is higher.
Taxes. Figure how much your income will be and then look at the tax tables. This is an essential part of your pre-retirement planning. Ask yourself these questions:
Should I roll over my company savings plan into an IRA and defer taxes or report it as taxable income currently?
What’s the best way to start withdrawing money from my IRA?
Should I establish a Roth IRA?
Family. After you retire, there is a possibility you might still be financially responsible for your parents or children, making you a part of what is being called the “sandwich” generation (people taking care of both their children and their parents).
Your estate planning should include provisions for family members, as well as the legal instruments necessary to keep you and them from being burdened should you develop a debilitating illness or die suddenly.
Health insurance. First of all, make sure you understand your employer’s policies on retired employee benefits. More and more companies are looking to scale back or eliminate health benefits for retired employees. You might need to add a Medicare supplement, so you’ll need to research all the options (and there are many) and figure the costs into your retirement calculations.
Talk to a professional. Finding the right financial advisor that fits your needs doesn’t have to be hard. It’s a given that your advisor should be knowledgeable and experienced, but most importantly, he or she should be a fiduciary, legally bound to act in your best interests.
The bottom line here? The quicker you get your estate and financial affairs in order, the better off you’ll be. You may find that you still have to save during retirement since inflation erodes your purchasing power. You don’t want your retirement savings to run out.
Consult your tax adviser and financial planner concerning your particular situation.
Retirement is not an ending; it’s the beginning of a new phase in your life.