How To Plan for Retirement: A 4-Step Guide
You plan to do a lot of relaxing in your golden years, but you know that requires careful planning for retirement now. Whether you are just beginning your career or want to make up for lost time, you’re ready to create a savings plan that will allow you to retire comfortably.
The thing is, the entire process makes you feel a bit overwhelmed. You’re not sure how much you should be putting aside or even what savings products to use.
Ready to start learning more about retirement savings? Here’s a guide that covers all the basics.
What Are the 4 Basic Steps of Retirement Planning?
1. Set Retirement Goals
When you first start to think, “How do I begin to plan for my retirement?” it can feel overwhelming. Therefore, it’s best to break this question up a bit.
First, you’ll want to set a target age for retirement. Something to keep in mind — results of a 2021 Gallup poll revealed that the mean expected age for retirees is 64, but the actual mean retirement age is 62.
You can start receiving Social Security retirement benefits at age 62, but your benefits will be reduced a small percentage for each month before your full retirement age. The month and year you reach your full retirement age is determined by the year you were born — e.g., age 67 for anyone born in 1960 and after.
Second, you’ll need to think about the kind of lifestyle you want in retirement. Some questions you’ll want to ask yourself include:
- Will I quit work altogether or work part time?
- Where will I live?
- Do I want to spend a lot of time traveling?
- Approximately how much will my monthly lifestyle cost?
This will build the foundation you need to start planning for retirement because it offers a snapshot of the finances you’ll need to fund your desired lifestyle.
2. Determine How Much Money You’ll Need
A big part of enjoying retirement is having enough money to live the lifestyle you want. Therefore, you’re probably wondering, “What is a good monthly retirement income?”
Generally speaking, you’ll need 70% to 90% of your pre-retirement income to maintain your current standard of living in retirement, according to the U.S. Department of Labor. Therefore, if you’re currently earning $60,000 per year, you’ll likely need $42,000 to $54,000 per year in retirement — $3,500 to $4,500 per month.
If you think Social Security will cover most of this cost, you’re probably mistaken.
As of June 2022, the average Social Security benefit is $1,542.22 per month, according to the Social Security Administration. Considering this equates to just $18,506.64 per year, it’s not surprising that these benefits only compose approximately 30% of seniors’ income.
To put it in perspective, only 12% of men and 15% of women rely on Social Security for 90% or more of their income, so the importance of having additional sources of income to rely on cannot be emphasized enough.
3. Decide What Retirement Savings Accounts You’ll Use
Putting money aside in savings is a big part of planning for retirement. There are several different options, including employer-sponsored plans and IRAs.
Here’s an overview of a few of the most common types of retirement savings accounts:
An employer-sponsored 401(k) allows you to defer a portion of your income to your retirement plan. Deductions are typically withdrawn from your paycheck automatically, and the amount you put aside is excluded from your taxable income. Employers are also able to contribute to your account, so if your company has an employer match incentive, it’s highly advisable to match it to the highest level.
If you’re a business owner with no employees, you can open a one-participant 401(k). This plan has the same rules and requirements as all 401(k) plans.
A type of retirement plan offered by public schools and some nonprofit organizations, a 403(b) plan is similar to a 401(k). Employers can contribute to your account, and the portion of your deferred salary isn’t typically subject to federal or state taxes until it’s distributed. If your employer matches contributions to a certain level, it’s wise to take full advantage of this perk.
A traditional IRA — individual retirement account — allows you to save for retirement, while reaping tax benefits. Depending on your filing status and income, your contributions may be fully or partially deductible. In most cases, funds in your IRA are not taxed until you take a distribution.
A Roth IRA follows the same rules as a traditional IRA, with a few exceptions. For example, you cannot deduct contributions to a Roth IRA. However, if you meet the requirements, qualified distributions are tax-free.
If you have a Savings Incentive Match Plan for Employees, both you and your employer can contribute to your traditional IRA. This is most commonly used as a start-up retirement savings plan by small employers that don’t currently sponsor a retirement plan, according to the IRS.
Employers are required to contribute either a matching contribution of up to 3% of your annual compensation or a 2% nonelective contribution for each eligible employee. You are always 100% vested — i.e., own all your money — in a SIMPLE IRA.
4. Don’t Touch Your Retirement Savings
When checking the balance of your retirement savings, it can be tempting to just let all that money sit there. However, it’s important to never dip into these accounts, unless you’re facing seriously extenuating circumstances.
Taking loans and early withdrawals can set your retirement plans back years. It can also be very costly.
For example, if your 401(k) plan allows you to take a loan, you’ll be required to repay it — including interest — according to strict terms. If you don’t adhere to these requirements, any unpaid amounts will become a plan distribution.
In most cases, you’ll have to include any previously untaxed amount of the distribution in your gross income the year the distribution occurred, and you might also face an additional 10% tax on the amount of the taxable distribution.
What Should I Do 5 Years Before Retirement?
If you’re planning for retirement in the next five years, you’re probably getting excited for this new chapter. You want to make sure you’re taking the right steps now to ensure a smooth financial transition into your golden years.
Some actions to take include the following:
- Maximize all of your retirement accounts if you have the ability to do so.
- Pay down as much debt as possible.
- Consider purchasing supplemental coverage to assist with medical costs.
- If you haven’t already, reach out to a fee-only financial planner to make sure your investment plan is on track.
- Decide exactly where you’ll live and use this to determine your estimated cost of living.
- Take a closer look at your estimated Social Security monthly benefit.
- If you don’t already, make sure you have an emergency fund in place, so you don’t have to take extra money out of a taxable retirement fund or get a job if you’re faced with an unexpected major expense.
It’s never too early or too late to start planning for retirement. Thinking about the kind of life you want and taking steps to prepare for it now will allow you to truly enjoy your golden years.
Even if retirement is a long way away, the actions you take today will hugely impact your future. Opening a retirement savings account and contributing a portion of each paycheck might mean you have to sacrifice a bit now, but that’s nothing compared to the amount you’ll have to stretch your budget in retirement without proper savings.
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- Gallup. 2021. "U.S. Retirees' Experience Differs From Nonretirees' Outlook."
- Social Security Administration. "Starting Your Retirement Benefits Early."
- Social Security Administration. 2022. "Monthly Statistical Snapshot, June 2022."
- Social Security Administration. "If you were born between 1960 your full retirement age is 67."
- IRS. 2021. "One-Participant 401(k) Plans."
- IRS. 2022. "IRC 403(b) Tax-Sheltered Annuity Plans."
- IRS. 2022. "SIMPLE IRA Plan."
- IRS. 2022. "Considering a loan from your 401(k) plan?"