If you’re thinking about retirement, then you probably also know the importance of having a plan to get there. Whether you’re early on in your career or counting down the years, we’ve broken down the steps you need to know about retirement planning. Follow these steps to ensure you’ll be ready to live out your best years when they arrive.
The Basic Components of Retirement Planning
The foundation of any retirement plan is to know the numbers that go into your plan.
- Time: How many years will you spend in retirement
- How old are you now?
- How old do you want to be when you stop working?
- Your retirement savings
- How much are you regularly saving for your retirement goal?
- How much have you already saved?
- What assumption can you make about the investment return on your retirement savings?
- Your additional potential income in retirement
- Passive (non-working) income like pensions, rental income after expenses, business income
- Social Security income
- Your spending in retirement
- In terms of dollars, or
- In terms of a percentage of your current income
First, you’ll want to predict how long your retirement will actually be. Does longevity run in your family? Do you want to keep working well into your golden years? Do you think you’ll want to retire early? Try to identify a specific date or age you wish to retire.
Next, you’ll want to take a look at your current savings. Take stock of your current retirement savings (like investments, 401(k) retirement plans at work or in your Individual Retirement Account (IRA), and potential windfalls like an inheritance), as well as your potential income sources in retirement (like unlocking equity in your home, pensions, business or rental income, and Social Security).
You also need to figure out what type of lifestyle you’d like to have in retirement and estimate what the related expenses will be. Take into account your current living expenses, as well as any future changes. For example, some of your costs could go up (such as health care), while others could go down (such as housing and commuting). Do you envision a relaxing, no-frills retirement in a smaller home? Or do you plan on taking several lavish vacations and living it up? A simple way to estimate this is to look at how much you spend today and use a percentage of that number.
Then, you’ll want to think about the returns your investments will earn, and these depend on your investment strategy (which we’ll cover in more detail below) and your tolerance for risk. Are you younger with sufficient time to recover any losses in the stock market? Or are you more comfortable if you don’t take on as much risk even if it means lower investment returns?
Once you have these numbers in mind, you can use a simple online retirement calculator as a starting point to get to know the different factors that go into your retirement plan. There are online calculators from reputable sources that use financial research and assumptions to do the math for you. Based on the numbers, you can look at which of the factors affecting your plan that you can control as best you can to help you come up with a more achievable result.
- One approach is to know whether you have a surplus or a shortfall in your retirement savings. With the number inputs described above, the Schwab Retirement Calculator will illustrate whether you will have enough — or not enough — to cover your spending needs in retirement.
- Another retirement calculator result will tell you how much you’ll have in projected retirement income per month in contrast to how much you would like to spend. The Vanguard Retirement Income Calculator takes this approach using the same inputs described above.
- The AARP retirement calculator combines both approaches, showing you the surplus or shortfall in your savings, as well as the annual withdrawals to support your lifestyle in retirement.
In all these calculators, you have the option to adjust the different inputs — time in retirement, savings per year, spending requirements — to see if you can have a more achievable and desirable result. These options represent the adjustments or trade-off decisions you might have to make to ensure you don’t run out of money in retirement.
If you have a shortfall in retirement savings or monthly income, consider working longer (delaying retirement, if possible) and increasing your savings rate if you really don’t like the idea of lowering your lifestyle costs in retirement. If you have a surplus and have more savings than your projected retirement spending, you can tinker with the idea of retiring sooner or feel good about leaving an inheritance for your loved ones.
Note that your assumptions for investment returns can help improve your results, but assuming a higher return (and presumably more risk) will not make up the gap if the savings rate is too low or retirement spending is too high.
Taking a DIY approach by using these calculators is already a big step towards retirement planning. You’re now familiar with the numbers that go into the plan, and the decisions and tradeoffs you might need to make.
Are these calculators perfect? Will life happen exactly as you plan it to be? Not at all! But these calculations serve to jumpstart your education and motivation. You’ll get a gauge of how you’re doing, and gain ideas of what you need to watch out for and what you might need to do next.
You might decide after using these simplified retirement calculators that you need more analysis, if you have a more complex financial situation for example, or that you want more guidance from a professional. Consult with a financial planner or investment adviser to go deeper into your plan than what these calculators can provide. You’ll have a more productive dialogue with financial advisors regarding your retirement plan if you have clarity around the inputs discussed above.
Retirement planning also largely depends on the stage of life you’re in. Your savings strategy in your 20s will differ from your savings strategy in your 50s. Below, we’ve briefly broken down what you should keep in mind during each stage of retirement planning.
Early Working Years
Retirement planning overview:
- You have time on your side, as your earnings will have more time to grow. Starting early with consistent savings habits will serve you well in the years ahead.
- Consider investing in a more aggressive diversified portfolio that includes more allocation towards stocks and less in bonds.
- You can consider looking at Target Date Funds if you wish to simplify your investing strategy. (Target Date Funds automatically adjust the allocation of stocks and bonds depending on the stage of retirement planning you’re in.)
In your early working years, you’ll likely have other financial goals, such as buying your first home or paying off your student loan debt or credit card debt. But it’s still important to invest money for retirement to give your money as much time as possible to grow.
Try to figure out how much you’ll need to save now in order to have the retirement you dream of. Figure out a monthly or yearly number as your savings goal, then begin working toward that goal.
If you have an employer 401(k), contribute at least what your employer matches, if not more. If you don’t have an employer-sponsored 401(k), open an Individual Retirement Account, either a Roth IRA or a Traditional IRA. There are differences between a 401(k) and an IRA, but both are powerful for your retirement savings. You can automate your savings strategy by setting up a direct deposit that goes directly from your paycheck to your retirement account. Remember, starting your retirement savings while you’re in your 20s is a huge advantage, so make the most of it.
Retirement planning overview:
- If you’ve been saving consistently, keep up the good work!
- If you’re just now getting around to saving, get started right away in a retirement account mentioned above. Use a retirement calculator to see how much more you’ll need to save to catch up.
- You still have time on your side, meaning you can still lean towards growth in your portfolio by taking moderate risks in your allocation of stocks and bonds.
- Review your Social Security statement at ssa.gov to ensure you’re getting the required credits to qualify for Social Security when you retire. Review your earnings history and see if your earnings over the years have been reported accurately. Your Social Security statement will also provide you with your potential monthly benefit in retirement, and can be used in your retirement plan calculations.
Mid-way through your career, your priorities will be continuing to save and invest. These can be your peak earning years — or you could experience setbacks. It all depends on your personal situation. Regardless of what happens, find ways to continue saving for retirement.
If you’re interested in working with a financial planner, this is a great time to consult one. Financial planners or advisors can run sophisticated calculations, present investment portfolios suitable for your situation, and help optimize for taxes with the right tax-advantaged investments and accounts.
If you’ve had multiple jobs over the course of your career, make sure you keep track of all of your 401(k) accounts from different employers. If you have several, consider consolidating them into an Individual Retirement Account (IRA).
Resist tapping into your retirement funds during this time. If you do, you’ll not only be delaying your retirement, but you’ll also have to pay penalties.
Retirement planning overview:
- Be attuned to the rules and regulations for withdrawing from your retirement accounts. For example, for IRAs and 401(k)s, you cannot withdraw earlier than 59 1/2 years old without incurring penalties. (Note the exceptions to penalties for withdrawals before age 59 1/2 rule.)
- Examine your retirement investments. You may want to adjust your investments to lean towards less volatile investments that also produce income, which could mean having a higher allocation in fixed income investments like bonds and less in stocks.
- Once you’re about to retire, you’ll want to move or sell a portion of your investments to throw off cash to pay for near-term living essentials.
Once you’re close to your desired retirement age, you’ll want to take a hard look at your finances. What exactly do you need to make your retirement a reality? What do you have now? Run your retirement calculations again to make sure you’re on track to have enough saved for the lifestyle you envision. Get professional guidance from financial advisors if you need it.
During this time, you’ll want to again review your Social Security statement for accuracy and know the various Social Security rules for collecting retirement benefits. Account for your potential retirement income sources during this time — things like investments, pensions, rental income, etc. This stage is also a good time to ensure you have health insurance covered during your retirement.
Retirement planning overview:
- You’ll want to move your investments toward safer, more conservative options, shifting to more bonds and fewer stocks for more stability in your retirement nest egg.
- Consider savings accounts like Certificates of Deposit (CDs) and bond accounts, which can produce a steady stream of income.
- This stage is when you’ll tap into your retirement savings to generate income for your living expenses. Be aware of the different taxes due on withdrawals from your Traditional or Roth IRAs and 401ks and your taxable accounts. A financial planner can help you decide on an optimal way to generate retirement income in the most efficient way, minimizing income taxes and transaction costs.
- If you plan on having a long retirement, keep a slice of your investments in stocks to help your accounts continue to grow and keep up with inflation.
- Monitor your spending and income. This is the time when the retirement planning you’ve done becomes reality.
Once you hit retirement age, the most important thing is to make a budget for your life and compare it to your income sources. Do you need to make any adjustments? Should you tap into the equity of your home and move to a smaller place? For many, downsizing and selling their home to reap the equity gained from decades of home ownership can be a great way to bolster retirement savings.
If you’ve reached the retirement age to qualify for Social Security benefits, you’ll also want to apply. Just resist collecting before your full retirement age, which is 66 or 67, depending on the year you were born. If you can defer collecting your Social Security until age 70, which is often advisable, as you can get as much as 132% of your monthly benefit for waiting past your full retirement age.
If you’ve been lucky enough to not need the extra income and deferred withdrawals from your qualified retirement accounts such as a 401(k) or IRA, note the rules around Required Minimum Distributions (RMDs) that could result in penalties if they’re not followed. At age 70 1/2, the IRS requires that you begin taking at least the minimum withdrawals on these accounts according to its schedule. Roth IRAs are the exception, as they are exempt from the RMD rules while the account owner is still alive.
Getting on the Path to Retirement
Retirement planning happens in four key steps: 1. Knowing your numbers, 2. Saving early, and saving often, 3. Getting professional help if you need it, and 4. Checking your plan regularly as you save and as you prepare to make withdrawals to make sure you’re on track.
If you keep these guidelines in mind, you’ll be well on your way to a better plan for a comfortable retirement in no time. For help getting started, consider reading this beginner’s guide to investing for retirement.