Retirement Planning 101: What You Need to Know to Build a Secure Retirement Plan
Looking for information on retirement planning?
You're in the right place!
In this article, we will break down some of the basics of retirement planning, including:
- How to figure out how much you need to save
- How and where to save
- The differences between different types of retirement plans
- The big piece that most retirement plans are missing
- And much more!
Why Retirement Planning Is Important
When it comes to retirement planning, you have probably heard that the earlier you start, the better.
However, this doesn't mean there is no hope if you are nearing your retirement years and you don't have enough saved. There are plenty of strategies to help you catch up if you are late in the game, and a qualified retirement planner can help walk you through your options.
However, due to the power of compounding, it is certainly best to start saving for retirement as early as you can, and to save as much as you can. With inflation driving up the cost of goods and services every year, plus an uncertain tax horizon, along with the instability of social programs such as Social Security and Medicare and the ballooning cost of medical and long-term care, you will likely need to have more saved for retirement than you expect - especially considering that we now live an average of 20-30 years longer than we did when Social Security was first conceived!
Although the latest latest Bureau of Labor Statistics data (based on 2016 figures) show that retired households spend an average of $12,000 less per year than younger households, they still spend an average of $45,756 per year - meaning, to continue this level of spending throughout retirement, they would need to have over $1.1 Million saved.
Unfortunately, statistics show that most Americans will fall far short of the savings they need for a comfortable retirement. A 2016 study by the Economic Policy Institute found that the average retirement savings of U.S. workers within 10 years of retirement was less than $170,000 - a number that, according to the popular 4% rule for retirement withdrawals, would yield an income of $7,000 per year - barely enough to cover groceries - let alone any other living expenses!
Looking at these numbers, it is obvious why it is SO important to plan ahead for retirement.
How Much Do You Need to Save for Retirement?
While the amount that you will need to save to retire comfortably will vary considerably from one person to the next, there are many tools out there to help you develop a good estimate for your particular needs and goals. The first thing you will want to do is to consider the 4 most important questions about your retirement plan. (You can review the 4 questions here.)
The answers will vary for each individual, and consulting with a qualified retirement planning specialist who has experience helping clients answer these questions is always a wise idea. However, if you want to try determine your specific answers on your own, there are a few steps you can take to get started on the right path:
- To start with, you can use a net worth calculator to figure out what you currently have. From there, you will want to develop an estimate of your expected expenses during retirement. This can be difficult to determine if you are still a decade or more away from retirement, but do your best using today's costs, and add on a bit extra for inflation depending on when you plan to retire. You can even create a mock retirement budget, and outline your expected living expenses and bills - including housing and utilities (for the area where you plan to live during your retirement years), transportation costs, insurance premiums (including health insurance), and potential healthcare expenses. (See this post on How to Create a Projected Retirement Budget.)
- Once you have listed all of your monthly expenses, multiply this number by 12 to get a good idea of your annual expenses during retirement, then multiply that by the number of years you expect to spend in retirement. For example, if you calculated that your annual expenses during retirement will be around $60,000 per year, and you expect to live 25 years after retiring, you will need to have at least $1.5 Million saved by the time you retire. But remember to add some extra for inflation, and, of course, don't forget about taxes! As we will discuss below in more detail, if you have much of your retirement savings in tax-deferred accounts, you will need to save extra beyond simply what you will need for your living expenses to cover taxes. The extra amount will depend on your tax bracket as well as tax thresholds during your retirement years. You won't know exactly what those are (they change all the time), but you can use your current tax bracket as an estimate.
- The next step will simply be to compare your current savings to your estimated number that you just came up with for total retirement expenses, and then you will know how much you need to have saved. A calculator like this one can help you estimate how long your retirement savings will last. There are also strategies like the 4% rule that may be helpful, although you should be aware that these do not provide a one-size-fits-all answer, and may not be right for your specific situation. (Read more about the problems with the 4% rule here.)
If this whole process sounds too overwhelming to you, take it one step at a time, and get help if you need it! There are many excellent retirement planning specialists who have specialized tools designed to specifically answer the 4 retirement questions for you, and they can run highly accurate estimates of how much you need to have saved, as well as how to best withdraw your retirement savings to make your money last as long as possible.
Once you have an idea of how much you will need to save for retirement, the next question is, where should you save it?
Keep reading as we provide a detailed look at some of the options...
Types of Retirement Plans
When it comes to retirement planning, you have a number of options to choose from. While it is good to have options, it can also be confusing for the average individual, who may not have much experience in the financial world. Should you invest in qualified plans, or non-qualified plans? Are market-based vehicles the best way to get a good return on your investment, or should you diversify into non-market based strategies to mitigate risk - and how should your plan change as you progress through your working years and into retirement?
These are all important questions to address. In this section, we will break down some of the main options that are available to you, so that you can better understand which type of retirement plan may work best for you in a given situation.
Qualified plans are also known as tax-deferred plans, and they include many of the most common retirement vehicles that most U.S. workers invest in, including 401k plans, 403b plans, and variations of these. In an employee-sponsored qualified or tax-deferred retirement plan, you may save a certain percentage of your income automatically through pre-tax withholdings from your paycheck, and you won't immediately pay taxes on the amount of your contribution.
These plans will typically be provided by your employer, and some employers may match up to a certain percentage of your income as long as you are contributing at least that much to your plan. For example, if you contribute 6% of your income to your 401k plan, your employer may choose to "match" up to 3%, giving you added retirement savings above and beyond what you contributed.
Self-directed IRAs are also tax-deferred plans which may be set up by individuals, rather than through your employer. (Roth IRAs are a unique example of one of the few commonly used non-tax-deferred retirement vehicles, which we will discuss in more detail below.)
Many people see the tax-deferral option as a great way to save more for the future - and it is true that having some form of automated savings is one of the best ways to make sure that you are saving for your retirement years. However, it is easy to forget that these plans are not tax-free - and that you will have to pay taxes on the money when you withdraw it for retirement purposes. When you look at your 401k plan and see that you have $1 million saved for retirement, don't forget that this isn't all your money! This is a common mistake that many people make when planning for retirement.
When planning for retirement, make sure that you account for future taxes, and keep in mind that your tax bracket may not be the same when you retire as it is now. In fact, even if you are retiring in a lower tax bracket, tax laws change all the time, so this doesn't necessarily mean you will be paying less in taxes.
Non-qualified plans are tax-deferred and employer-sponsored retirement plans that don't meet the stringent requirements for a qualified plan. They are often designed to meet special retirement needs for key executives or other similar high-level employees.
The 4 major types of non-qualified retirement plans are deferred-compensation plans (often provided to government employees or teachers), executive bonus plans, group carve-out plans and split-dollar life insurance plans.
Deferred compensation plans allow earnings within the plan to accumulate on a tax-deferred basis, and employees will have to pay taxes on the gains when they take the money out in retirement - as they would with a qualified plan.
For most other types of non-qualified plans, contributions are taxed when the income is earned, meaning that the employees will pay immediate income taxes on these benefits.
Most employer-sponsored retirement plans - both qualified and non-qualified - are largely market-based, meaning that the value in your plan may grow or shrink based on market conditions.
There are exceptions, such as non-qualified employer-sponsored life insurance plans like split-dollar plans or executive bonus plans that involve a non-variable life insurance policy. However, for most people, all or most of your retirement savings are likely tied in some way to market performance. Of course, there are upsides and downsides to investing in the stock market. The upside is, when market conditions are good, you may see substantial growth in your plan. On the flip side, you could also see a dramatic drop in the value of your retirement savings if the market declines suddenly.
While you are young, market swings may not concern you too much. However, as you near your desired retirement date, it may be wise to diversify into less volatile options. You should make sure to consult with a qualified retirement planning advisor before making any investment moves that could impact your future retirement goals.
Many people's retirement plans are not well-diversified between market-based and non-market-based vehicles. In fact, many people are not even aware of the non-market-based options that may be available to them. These products provide a buffer against market volatility, and they may also offer some inflation protection. They will usually have less of a potential upside (gain) than market-based retirement plans, but also a smaller risk of loss. As you near your retirement years, shifting some of your assets from market-based to non-market-based strategies can help to protect your retirement plan and make sure that the money is there for you when you need it.
While many people discount these conservative savings strategies as "too expensive," or "low-return," it is important to remember that the return OF your money is just as important as the return ON your money - especially as you near retirement.
We have an unfortunate tendency in today's society to conflate saving with investing, when they actually are not the same thing.
Saving is what you do with money that you know you will need to have for a future use.
Investing is what you do with money that you can afford to potentially lose, in the hope of gaining a return.
While it is perfectly fine to utilize both strategies, as you near retirement, you need to ask yourself if you want most of the money you will need to fund your retirement needs to be saved, or invested.
That is, how much of your retirement funds could you afford to lose?
Keep in mind that the answer to this question may (and should) change as you draw closer to retirement, but asking yourself this question every so often as you go through your working years will help you to determine how to allocate your retirement funds between market-based and non-market-based strategies. A qualified retirement planner who has substantial experience with retirement income planning as well as both market-based and non-market-based strategies can help you to make the best decision for your individual situation.
Retirement Savings Options
When it comes to saving for retirement, there are nearly endless options available. Your chosen retirement savings vehicle will fall into one or more of the categories discussed above, but when it comes to individual savings plans, there are numerous plan options available to you. Some of the most popular choices are 401k plans (or 403b plans, depending on your place of employment), various types of IRAs, annuities, and deferred compensation plans. Other options include money market accounts, CDs, whole life insurance plans, savings bonds, savings accounts at the bank, and other, more specialized options.
These products fill the whole spectrum of risk, depending on whether they are subject to the whims of the stock market or not. Your 401k plan may be largely or entirely invested in stock market assets, which will be subject to potential stock market losses, but also could attain higher gains than other vehicles if the markets perform well. On the other hand, having your money in a CD may be very safe and secure with a predictable rate of return that you can count on. However, the returns are typically quite low, and if you need the money on short notice, your access to the money will be limited.
As we discussed above, you will need to determine how much of your retirement savings you want invested (subject to losses but with potential higher returns), versus how much you want saved (with a predictable return that you can count on), in order to choose the right vehicle(s) for you.
Which retirement savings plan is best for you will depend on a whole host of individual factors, including age, income, desired retirement age, potential health concerns, expected longevity, risk tolerance, and more. For most people, a combination of several different vehicles will make sense, and this blend may change over time as you near your retirement years.
Figuring out the right allocation of savings for your specific situation and goals can be very complicated, which is why you may want to consult with a qualified retirement planning advisor who can help you determine which blend of which vehicles will best help you achieve your long-term retirement goals.
Retirement Income Planning: What Most Retirement Plans Are Missing
Once you have determined how much you need to save for retirement, which types of retirement plans make the most sense for you, and where to save, you're all set for retirement, right?
Not so fast...
Saving for retirement during your working years is only the first piece of the puzzle - sometimes called the "accumulation phase." Unfortunately, many traditional retirement planners don't go much beyond this phase, leaving you to figure out the second piece - the distribution phase - on your own.
What many people don't realize is that getting the distribution phase right is just as important as the accumulation phase, yet it receives far less attention from most financial planners! After you spent your whole life saving for retirement, don't you want to make sure that you know how to spend that money properly, so that it lasts you the rest of your life and you don't run out earlier than you had expected?
We all think we know how to spend money just fine on our own, but the truth is that the strategy you use to take money from your retirement plans can make a huge difference in how long your money lasts!
For an eye-opening example of this, see the table below. In this example, even though the overall rate of return was higher in the first example and they took the same amount of income every year, you will see that Mr. Johnson runs out of money before Ms. Hamilton simply because there were a few down years early in the distribution phase. In technical terms, this is called the "sequence of returns," and it can have a significant impact on how long your retirement savings last you - depending on where you are pulling your money from.
(For a larger view, click here.)
Another thing to keep in mind is that, as you near the distribution phase, you will want to take a close look at your retirement plan and make adjustments according to your updated risk tolerance. For example, if you have a lot of money in market-based investments, you will have less time for the value of your accounts to recover should the stock market take a hit shortly before you retire. In this case, it may be a good idea to move some of your retirement savings into more conservative strategies to protect your gains and keep your money safe in preparation for starting distributions. As you can see in the example above, taking money out of your plan during a down market can have disastrous consequences for your long-term savings.
Before making any moves, it would be a good idea to consult with a professional retirement planner who has tools that can help you project how long your money will last during various market scenarios, and what is the best way to take distributions to make your money last throughout your lifetime.
Other Considerations That May Impact Your Retirement Plan
As you can see, planning properly for retirement has a lot of moving pieces! Besides the topics mentioned above, there are some other factors that can also impact your retirement plan and which you will want to consider when planning. Some of the biggest factors that you will want to keep in mind are
You can click the links above for more information on each of these topics, but working with a holistic financial planner who can help you coordinate all of these pieces to meet your needs is always a good idea.
Why You May Want to Consider A Holistic Retirement Planning Solution
If you have read this far, by now you probably realize that retirement planning is an extremely complex topic with many moving pieces, which is why so many people choose to seek help at some point in the process. However, many traditional financial advisors only focus on one or two pieces of the puzzle, leaving you to figure out the rest on your own. This can lead many retirees to run out of money far before they had expected - or have to work a lot longer than they had anticipated.
This is why we recommend a more holistic approach to retirement planning. By considering every aspect of your financial journey - from your working and saving years (where and how to save to achieve the results you are looking for), all the way through into your retirement years (Social Security and income strategies to help your money last as long as you do) and even beyond (estate and legacy planning) - a holistic retirement planner can help you to develop a retirement plan that will suit your individual needs, goals, and desires.
For example, at Eagle Financial Solutions, we provide lots of educational resources to help our clients learn about the strategies we use, so that you can make an informed decision on what strategies would be best for you, rather than just "buying a product." We work one-on-one with each individual to help make sure you understand our processes, methods, and recommended strategies before you make any decisions, and we utilize comprehensive planning tools that will analyze your entire financial picture - rather than just one piece of the puzzle.
By taking a holistic approach, we feel that we are better equipped to help every individual achieve his or her unique retirement goals - rather than just trying to fit everyone into the same "one-size-fit-all" product or strategy. It may be a bit more work for us up front, but in the long run, we are building long-term relationships that will bring us future generations of happy clients!
If you would like to see what a holistic retirement planning solution would look like for your particular needs and goals, please feel free to get in touch with our office to request a free initial one-on-one retirement strategy session! You may fill out the contact form here, or call our scheduling department at 614-536-0088, and our friendly staff will be happy to assist you.