Retirement planning is an integral part of your overall financial plan. Strategies should be designed to suit your goals and comfort level as well as take advantage of tax saving opportunities. For any plan to be effective, it is necessary to implement these strategies and to review your goals and progress periodically.
The amount you will need in retirement depends on the age you plan to retire, your desired retirement lifestyle, how long you expect to live and the rate of return that you seek to earn on your investments. Social Security and employer-sponsored pension plans will probably provide a smaller percentage of what you will need than they did for your parents. The most important aspect of projecting your future needs is estimating how much you will have to save each year to help produce the income you need to maintain your standard of living after you stop working.
Pre-Retirement Considerations
Consider using one or more of the following strategies to maximize you retirement income:
Invest to earn a potentially higher rate of return on investments
In a retirement plan, assets that have the potential for significant growth over the long-term should be considered. It is important that your investment choices be consistent with the level of risk that you are willing to assume. In addition, good financial planning must always take inflation into account. If you disregard inflation, you may end up investing too conservatively. Together we can determine a suitable mix of investments that meets your objectives, time frame, and risk tolerance.
Save more
It is hard to motivate yourself to save for retirement because it generally requires spending less money now. You will have a much better chance of achieving your retirement goal if you maintain (or even reduce) today's standard of living and save as much as you can. Many retirement planners generally suggest committing 10% to 15% of your gross earnings, or earnings before tax, to savings for retirement.
Spend less during retirement
Many retirement experts estimate that you need between 70% and 80% of your pre-retirement income to maintain your standard of living during retirement. This may or may not be appropriate for you, as everyone’s goals are different. Some of your expenses will increase and others will decrease; you may spend less on business clothing and lunches, but more on vacations. Also consider the differences in your living expenses for early and later phases of retirement. For example, you will likely spend more on travel when you are 65 than when you are 85.
Retire at a later age
The effect of retiring later is two-fold. Not only will you have contributed to your retirement plan for more years but also your salary is typically higher at the end of your career. Retiring early means losing retirement plan contributions based on those higher income amounts. This will normally result in a smaller pension. Retiring earlier also means that you will likely be retired longer and therefore dependent upon income from your investments for a greater number of years.
Maximize Contributions to Qualified Retirement Plans
Many retirement accounts have a dual advantage: contributions are deducted from current taxable income, and the account itself grows tax deferred. Below is a partial list of retirement accounts that may be available to you.
401(k) Plan
A voluntary retirement savings plan that is funded primarily by the pre-tax contributions of employees. However, employers will frequently match contributions to encourage participation. For example, an employer may match $.50 on every $1.00 contributed by the employee up to 5% of salary.
403(b) Plan
Like the 401(k), this type of retirement plan is funded primarily with employee salary deferrals. Use of this plan, however, is limited to public schools, many state, county, and city hospitals, and tax-exempt or non-profit organizations such as religious, charitable, or scientific institutions.
Individual Retirement Account (IRA)
An IRA is a type of retirement plan that may allow your investments to grow tax-deferred until you begin regular withdrawals, which usually occurs after age 59 ½. Contributions are limited, and deductibility of contributions depends on salary level and whether the IRA owner or spouse participates in an employer-sponsored retirement plan. Traditional IRAs are subject to minimum withdrawals at age 70 ½.
Roth IRA
Roth IRAs are another type of retirement plan, which allow you to contribute after-tax dollars to the account. Contributions are limited and non-deductible, but any growth of these investments can be distributed tax-free. Eligibility depends on income levels. A Roth IRA generally permits tax-free and penalty-free withdrawals of earnings after five years and attainment of age 59 ½.
Withdrawals of contributions may be made at any time. Roth IRAs are not subject to the minimum distribution requirements during the owner’s lifetime.
Other qualified retirement plans may be more appropriate depending upon your employment situation. These include SEP IRA, Keogh, SIMPLE IRA and profit sharing plans.
Although there are exceptions, most retirement plans have penalties for withdrawals prior to 59 ½ and require minimum distributions at 70 ½.
The key starting point in reviewing your retirement needs is to determine an accurate estimate of your expenses during retirement. Many pre-retirement expenses will end once you retire, such as office parking, business lunches, etc. On the other hand, other expenses may increase.
Retirement may also consist of an active period early on where travel and other leisure activities are the major new expense items. The later part of retirement may include increased health care costs and reduced leisure expenses.
Next, you need to determine how best to utilize your various income sources in retirement. The following items need to be considered:
Retirement Considerations
Asset Allocation Review
As you enter retirement you should consider reviewing your asset allocation. Since your planning time horizon is shorter than when you first started work, you need to balance your need to grow your assets to keep pace with inflation, while preserving your investment capital, and providing income to meet your expense needs. It is quite likely that during retirement you may need to supplement social security and other pension plans with withdrawals from your investments. We should take a close look at your portfolio to determine how and if it needs to be rebalanced.
Social Security
Upon retirement another decision is when to begin receiving Social Security. You may begin taking a reduced benefit at age 62, wait until you are eligible to receive your full benefit or take an increased benefit by postponing your first payment until age 70. At 62, for example, you get only 80% of what you would have been eligible for had you started benefits at age 65. (People born in 1942 and later will be eligible for an even smaller percentage at age 62 because the age at which full benefits are paid will gradually increase from age 65 to 67.)
Liquidation of Non-Cash Assets
You may have some non-cash assets such as real estate or other property that you plan to sell to generate cash when you retire. Keep in mind that the ability to sell property and to obtain the value you require will depend on market conditions at the time you wish to sell. Also, there may be fees and tax consequences involved in such a transaction.
Which assets do I use first?
Your retirement assets may consist of both qualified and non-qualified assets. The decision on how to redeem these assets may have a significant impact on your plan. This decision will impact how long the funds will last and the tax implication during different stages of your retirement and at your death. Generally, it is better to use non-qualified assets first, and then qualified/IRA assets. However, we should discuss these alternatives and review the situation annually to determine what is best for your situation.
