Financial Planning for Retirement
There is probably no right or wrong time to start planning for retirement but one thing is certain: the sooner you start the better. Yet, while all of us would like a comfortable retirement, many people are too busy taking care of their current financial issues and postpone this presumably daunting process for an indefinite period of time.
However, retirement is expensive and the sooner you start, the more time you will have to accumulate the money needed to retire comfortably. You will save yourself a lot more headaches if you start at a younger age so start planning now. With just a little homework and some persistence you will see that planning for retirement is not that complicated or financially painful.
Why Plan for Retirement at All?
Before we start discussing how to create a successful retirement plan, let's review why we need to start planning in the first place.
Experts have estimated that generally we need about 70 percent of our pre-retirement income (that number increases to 90 percent for the lower earners) in order to be able to maintain our standard of life once we stop working. But where will this money come from?
Most people count on the following sources of income to fund their retirement:
- Social Security
- personal savings
Well, 70 percent of your pre-retirement income is not that easy to achieve.
First, you should know that you can expect only about 40 percent of your pre-retirement earnings if you receive full Social Security benefits.
Second, the average retiree (those that receive pension benefits at all) receives pension that amounts to only about 25 percent of their pre-retirement income.
Thus, even if you receive both Social Security and pension benefits in the best-case scenario, you will still have to count on what you have managed to save of your current income. Therefore you will need a sensible retirement plan in order to ensure yourself a financially secure retirement.
Calculate What You will Need for Retirement
How do you decide how much money will be enough to reach your retirement goals? Well, you will have to calculate that depending on your personal situation taking into account both your desired standard of living and your desired retirement age. Here are a few guides that will help you do the calculations:
|Determine your target retirement age.||Let's assume you want to retire at age 62.|
|Determine your desired standard of living.||For example, you estimate that you need $40,000 annually.|
|Estimate how much money you have currently in savings.||For example, you estimate that you have $50,000.|
|Estimate how much money you have currently in investments and assess what will be the realistic annual real rate of return on these investments.||For example, you estimate that you currently have $20,000 in investments and their real rate of return is 7%.|
|Estimate your pension benefits.||Since employer-sponsored plans are not very common today let's assume you don't have a pension plan.|
|Estimate your Social Security benefits. (You can check that on the SSA website)||Let's assume you are currently earning $50,000 a year and your target retirement age is 20 years from now. Thus, your estimated monthly benefit amount, beginning at age 62, will be $1,145. In other words you will get $13,740 per year.|
|Subtract your Social Security benefits from your desired annual retirement money in order to get the amount of money per year you must fund on your own.||In this case $40,000 - $13,740 = $26,260|
Estimate the size of your nest egg (how much money you need to have invested in order to get your desired annual amount from the annual real rate of return) after taxes.
You can use the following formula:
NE = AA / RRoR(1-Tax)
NE - the size of your nest egg
AA - the annual amount you need to fund on your own
RRoR - the real rate of return on your investments (in percentage)
Tax - the taxes on your investment income you will have to pay (in percentage)
In this case you need to fund on your own $26,260 per year, the taxes you expect to pay are let's say 20% and the real rate of return on your investments is 7%.
The size of your nest egg after taxes would be:
$26,260 / 0.07(1-0.2) = $468,929
In other words you will need a nest egg of about $470,000
If you didn't have to pay taxes on your investment income you would need a nest egg of: $26,260 / 0.07 = $375,143
Don't forget to take into account inflation and its effect on the future purchasing power of today's dollars. As you contribute to your retirement plan every year, simply keep abreast of inflation rates and revise your contributions when necessary.
Additionally, it is always a good advice to take into account other possible financial risks of retirement when you make your calculations, such as unexpected medical expenses, discontinuance of Social Security benefits, etc.
How to get the Money for Retirement
Once you have calculated how much money you will need to retire comfortably, there comes the question "how do I get that money for retirement?"
Well, saving a portion of your employment income is an obvious answer but this is not the whole picture. A comprehensive plan that will help you build your nest egg successfully will require using various retirement savings vehicles and a great deal of personal commitment to your contributions.
Here are some retirement savings sources and instruments you can use:
- Start with examining your
options at work.
You may choose a retirement plan through your employer. If you choose a retirement account like a 401(k) plan and SEP IRA you will be able to save for retirement with pre-tax dollars and take advantage of matching contributions if such are offered.
- Get familiar with IRAs.
Even if you are not offered a retirement plan by your company, you may still be able to make tax-deductible contributions to an IRA.
- Find out about your Social
As we already mentioned, Social Security may pay you about 40 percent of your pre-retirement earnings. Find out about your benefits but always have in mind that you may not be able to get the full benefits at your retirement age.
- Investigate annuities.
Retirees can purchase annuities through insurance companies, which provide a kind of retirement-income insurance. The good news is that if you choose this retirement planning instrument, your contributions will reduce your taxable earnings for the current year and you will benefit from tax-deferred growth.
Surely it is impossible to cover all aspects of retirement planning in one single article. However, now that you know the basics, start planning for your retirement now. The sooner you start saving, the more time you will have for your money to grow and the harder it will work for you.
Remember, a retirement plan requires commitment and starting your contributions to it at a younger age is one of the biggest factors in ensuring its success.
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