If the topic of retirement planning sets off waves of anxiety and confusion, you are not alone. Survey after survey shows it’s a major stress point for many. It’s easy to feel overwhelmed given what’s at stake.
Relax. You can ace retirement planning by exercising a few smart habits, and learning just a handful of key planning Must Dos.
Follow this 7-step retirement planning guide and you will land in retirement in solid shape whether your retirement is 5 years or 50 years off.
Your Retirement Guide—Made Easier
- Save at least 10% of your income with automatic deductions. If you waited until your 30s or later to get serious, make it 15%. Wonky folks have run the numbers and come to the conclusion that saving 10% to 15% per year is what it takes to have a good shot at a comfy retirement.
Sound impossible? Just try it for a few months. Most people find that once they commit they are able to adjust their spending to make it work. Set up an automatic deduction; that’s the best way to stay committed. If you have a workplace place, your contributions will come straight from your paycheck. If you are saving on your own, with an IRA, you can have monthly or quarterly contributions sent from your checking account into your retirement account, for free.
- Save in Retirement Accounts that Deliver Valuable Tax Breaks. If you have a workplace retirement plan, such as a 401(k) or 403(b), chances are you may have a choice of saving in a Traditional or Roth version.
With a Traditional 401(k), your annual contributions are pre-tax, which means it reduces your taxable income. Example: If you make $75,000 and contribute $7,500 your taxable income for the year will be 67,500, not $75,000. Nice deal, eh? Just be aware that in retirement you will pay income tax on every penny you withdraw from a Traditional 401(k) account.
With the Roth your contributions are after-tax. Translation: no tax break right now. But in retirement you will owe zero tax on your withdrawals. Having some retirement income that will be 100% tax free can be incredibly valuable. If you have the option of saving in a Roth 401(k), it’s worth considering. There is no income cutoff for being eligible for a Roth 401(k).
No workplace plan? Individual Retirement Accounts (IRAs) are the way to go. There are Traditional and Roth versions, but with a Roth IRA you have to meet an income test: In 2019, individuals with modified gross income below $122,000 and married couples filing a joint return with income below $193,000 are eligible to contribute the maximum. If you’re younger than 50, the max is $6,000. Crossed the 50-year line? You can save $7,000 a year in an IRA (Traditional or Roth.) If you’re self-employed, check out a SEP-IRA. It only comes in the Traditional flavor, but you can save a lot more than $6,000/$7,000 a year.
A Health Savings account (HSA) can also be used as a retirement account. In fact, the tax breaks you get with an HSA are even better than a 401(k) or IRA.
- Invest for the Long-Term. Over the long-term, stocks have delivered the best inflation-beating gains. Of course, from time to time they also suffer big losses. That’s where owning some bonds and cash can help; neither returns as much as stocks over the long term, but they aren’t volatile like stocks.
Finding the right stock-bond-cash mix is key. You likely want (need) stocks to increase the odds your money will grow at a pace that beats inflation. When you are young, you have plenty of time to ride out bad stock markets, so a higher investment in stocks can make sense. But even if you are in your 60s and near retirement, keep in mind that there’s a good chance you will still be alive for another 25 years. Owning some stocks still makes plenty of sense. If you have a workplace retirement plan, chances are you can use online tools to explore the right mix. Target date funds (TDFs) are a popular retirement investment where the fund controls the mix of stocks-bonds-cash, and sets the mix based on your age. You might want to consider a TDF, or use a TDF as a guide for determining the right mix given your age. (Each fund company with a TDF will have a link on its website to see the “portfolio” or “portfolio mix.”)
- Don’t Let the Kids Slow You Down. It is natural to want to do everything for your kids. But reducing your retirement contributions, or raiding your retirement savings to help pay for a child’s college costs is a dangerous mistake. If you don’t save now, how will you support yourself in retirement? There are loans for college, but not for retirement. Fast forward 20 or 30 years and your adult child will be relieved if you are in good financial shape when you retire. That means prioritizing retirement saving over college saving today.
- Plan on a (Very) Long Life. Two numbers that can make all the difference in successful retirement planning are 88 and 85. Those are the average life expectancies for 65-year-old women and men, respectively. That is, half of today’s 65 year old women will still be alive past age 88, and half of today’s 65-year old men will still be alive past age 85. As you may have already noticed in your family, living into your 90s is not some outlier event any more. Once you hit your mid 50s you should start using online tools (there are free ones) that will show you what sort of income your retirement savings can generate. A good “retirement income calculator” will preset your end age to at least 90, or 95. Given longevity trends, that’s how long you may need your income to keep supporting you.
- Consider Waiting to Claim Social Security. You can start receiving your Social Security retirement benefit once you turn 62. Tempting as it may be, it’s important to understand you are penalized for starting that early. The way the system works is that everyone has a Full Retirement Age (FRA); it’s somewhere between 66 and 67 depending on the year you were born.
Your FRA is when you are eligible to receive 100% of your earned benefit. When you claim at 62 your benefit will be just 70% or 75% of your FRA benefit. That’s an argument for waiting if you are motivated to generate more retirement income. An even better financial move is for the high earner in a household to wait until age 70 to start. Every year you delay past your FRA up through age 70 your benefit will be increased by 8%. So, someone with an FRA of 67 will be paid 124% of her FRA benefit if she waits until age 70 to start.
Even if you don’t want to work (or work full time) to age 70, delaying Social Security can boost your retirement security. Maybe you can just work enough to be able to bring in income before age 70 that would be equivalent to your Social Security benefit if you claimed early. (The average monthly benefit is around $1,400 a month.) Or you could live off of other retirement income from your savings.
- Factor in Your Retirement Health Expenses. Medicare will cover the bulk of your retirement health care costs, but not all. Typically, retirees are on the hook for about 30% of their health care costs. Not including long-term care costs (which are not covered by Medicare), a couple might spend $200,000 or more on out-of-pocket expenses over a long retirement.
This is where saving in a health savings account (HSA) can be a huge financial help in retirement. An HSA is the only investment account that offers you three tax breaks: you get to deduct the money you contribute, your money grows tax free, and when you use the money for a qualified health-care expense it will not be taxed.
You can use HSA savings to pay health care bills today, or let your HSA account grow and tap it in retirement. (Learn more about how an HSA can be a valuable stealth retirement savings account.) Using tax-free dollars to cover your health care costs can be a huge boost to your financial security.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.