Retirement 101 A Complete Guide to Retirement Planning
Intro: What's Retirement Planning?
Life indeed is a journey.
From beginning to end, life has many milestones —the first day of school, getting your DL, graduating college, scoring your first job, leaving your parental home, buying your first car/home, getting married, having kids, and retiring. The last milestone is probably the most challenging one.
Retirement is expensive because almost all the fun activities cost money. Just think about it – exotic travel vacations, shopping, playing golf, etc. The fun part of retirement is why it pays to pay attention to the serious (and maybe boring) part – planning how you'll get there.
Retirement planning is an indispensable part of a sound financial strategy. It means preparing today for your golden years so that you continue to meet all your financial goals independently.
Retirement planning begins with you setting your retirement goals, estimating how much money you'll need to retire comfortably.
It is also important to recognize your starting point today, on adopting a financial strategy (based on sound tax planning) and investing aggressively to grow your retirement savings.
But Retirement Is Years (Or Decades) Away…
In your youth, retirement may seem like a distant thing to worry about —something you may not need to plan for just yet. Many young people get overwhelmed about saving for an unknown future, so much that a good percentage ends up not saving anything at all.
Any worker nearing retirement age will tell you the years slip by fast, and saving becomes more difficult if you don't start early.
It's never too early to start preparing for your retirement. Ideally, the best time to start is when you get your first paycheck. You may not earn a lot as you start your career, but you have the luxury of time.
Retirement planning includes 3 phases – investment, accumulation, and withdrawal. When you invest earlier, there is sufficient time to take advantage of the power of compounding and tackle any unexpected challenges. No one knows what the future holds, but it can help to be prepared.
Next, you need to learn about the types of retirement accounts that can help you fund your future. When you secure a full-time job, your employer will likely offer matching contributions. It's vital to understand what these benefits are, how they work and how to take full advantage of them.
Even without an employer-sponsored plan, you can invest on your own and secure your retirement.
Creating a comfortable retirement is a challenge for which many working Americans are ill-prepared.
This guide discusses steps you need to follow to get you working on retirement planning. Feel free to read through from start to finish, or if you're in a rush, jump to the chapter(s) you want to learn more about.
Chapter 1. What Are Some of The Popular Retirement Plans?
While setting aside money is a critical part of retirement planning, you won't reach your goal without using a retirement plan.
How you invest in your retirement will not only determine how much money you'll have in retirement but also how you're taxed.
Many retirement plans exist, some employer-sponsored and others serving as personal investments, so you have plenty of great choices to realize your retirement goals.
There is no single best retirement plan. Each plan has merits and demerits. Some plans are pre-taxed, while others are post-taxed. There is likely an appropriate retirement plan (or combination of retirement accounts) for your individual needs.
To get the most out of retirement planning, it's critical to understand what your company offers. If you go the individual investment or self-employed route, ensure to discuss it with your tax or a financial advisor.
Common retirement plans include:
a. Individual Retirement Plans
If you are already saving, keep going! If you're not saving, you can set up an IRA at your bank, brokerage firm or IRA provider.
IRAs come in various forms, each with its unique set of characteristics (how much you can contribute, how the funds are taxed, etc.).
The most common IRAs are traditional IRAs, ROTH IRAs, rollover (conduit) IRAs, and spousal IRAs. They hold investments in stocks, bonds, cash, and mutual funds reserved for retirement.
Individual retirement plans can be a great tool for creating a comfortable and dignified retirement. They confer tax advantages, but at different times. If you qualify for both a traditional and ROTH IRA in the same year, you can contribute to both.
b. Employer-Sponsored Retirement Plans
Employer-sponsored plans typically deduct money on a pre-tax basis. The money taken from your paycheck is then deposited into an account and invested in a diversified portfolio of stocks and bonds.
They're established by employers and usually confer the benefit of employer-matched contributions. If your employer offers any of these retirement plans, don't leave the offer on the table.
Employer-sponsored plans include contribution plans like:
401(k) – most common employer-sponsored plan. Allows tax-deductible contributions, but for tax purposes, treats withdrawals in retirement as ordinary income.
457(b) – similar to a 401(k) but only available to state/local government employees and some nonprofit employees. No early withdrawal penalty if you leave your job.
403 (b) – similar to a 401(k) but only offered by nonprofits, public education institutions and ministries. Has higher limits for matches than 401(k).
Defined Benefits (Pension) Plan – provides a predictable, defined income monthly for life. Very few companies still offer pension plans.
Thrift Savings Plans (TSP) – similar to a 401(k) but only available to uniformed services personnel and federal government employees.
c. Retirement Plans for Self-Employed & Small Business Owners
If you're self-employed, you still have a few options that will enable you to enjoy the same tax advantages conferred by individual and employer-sponsored plans.
These include:
Savings Incentive Match Plans for Employees (SIMPLE) – suitable for employers with 100 or fewer employees.
Simplified Employee Pension (SEP) – requires employers to contribute 100 percent of the accounts fund. Employers should also provide equal benefits to all eligible employees.
Payroll Deduction IRAs – suitable for employers with one or more employees. Employees are subject to traditional and ROTH IRA eligibility requirements.
Solo 401(k) – similar to employer-sponsored 401(k) but features a higher annual contribution limit.
Chapter 2. What's the Difference Between Traditional IRA and ROTH IRA?
I'll save the debate of which is best for another time. But I think it is important that you understand the difference between the two.
a. Traditional IRA
A Traditional IRA is a tax-advantaged investing tool you can use to earmark your retirement savings.
As the name suggests, you can open and contribute to the account yourself. Depending on your employment status, IRAs can be of different types and attract different tax liabilities.
The main advantage of a traditional IRA is that contributions are generally tax-deductible. Also, the money can grow inside your account on a tax-deferred basis, allowing your money to compound at a quicker rate than it otherwise would.
While you'll have to pay applicable federal and state taxes on withdrawals, the tax will be based on your current year's tax rate. The good thing about this is that you'll probably earn little income in retirement, meaning you'll be in a lower tax bracket, which equals lower taxes. There's, however, a 10 percent penalty for withdrawing funds before you turn 59.5 years old.
You're currently allowed to contribute up to $6,000 per year for the 2022 tax year. Americans aged 50 and older can contribute up to $7,000 thanks to catch-up contributions. You must start removing money from your IRA once you turn 72.
b. ROTH IRA
Contributions to a ROTH IRA account are made with after-tax dollars. What this means is that you don't enjoy tax deductions on your contributions. The benefit of this is that you will not owe IRS a thing when it's finally time to withdraw —and that includes all the interest your contributions earned over all those years.
A Roth IRA is an effective retirement plan if you expect your taxes to be higher during retirement than they are right now.
Like a traditional IRA, you're allowed to contribute up to $6k a year or $7k if you're over 50.
There are, however, income limits on who can have a ROTH. These limits also depend on your tax-filing status (single or married).
If you earn over $129k (or $204k as a couple), your annual contribution room will be reduced or phased out. Also, you cannot contribute to this account if you earn over $144k or ($214k as a couple).
Chapter 3. Can I Write My Own Retirement Planning Guide? If Yes, How Do I Go About It?
Retirement is an ultimate reality that all working professionals face when they hit 66.
Most people use recycled retirement planning guides they find on the internet. These guides usually don't reflect the reality on the ground.
You see, today's savers face unique challenges that were unheard of in the previous generations. Life expectancy, for instance, is longer. People on average are living longer, meaning that you will need your money to stretch for longer.
Also, many employers are migrating from defined benefits pensions to defined contributions plans. The former guarantees you a certain amount of money in your retirement while the latter are more subject to markets ups and downs.
The good news is that you can write your own retirement planning guide. Every retirement plan is unique. We all have specific ideas on how we wish to spend our retired lives. This is why it's imperative to have a custom plan that suits your individual needs.
You retire from work, not life. So, start by thinking about what your life might look like in retirement, then calculate how much potentially everything will cost.
Here are a few questions you must seek answers for:
What do I yearn to do during my retirement?
What will be the cost of my retirement expenses?
Do I have adequate insurance cover?
How much should I allocate for my health care and medical needs?
What do I own? Can I generate cash inflows during my retirement?
Will I be debt-free?
Have representative expectations about post-retirement spending habits. Some of the costly expenses you're struggling with now, like childcare or mortgage costs will no longer exist, while others like healthcare, travel and entertainment costs will go up.
Next, sum up all the income you expect to receive in your post-working years – rental income from a property, social security payments, pension income, etc.
Match up expenses and revenue to get a good idea of how much you will need to set aside for every year of your retirement.
Chapter 4. Common and Costly Mistakes to Avoid in Retirement Planning
Not saving and investing early is the most common, regretted and costly mistake, according to most retirees.
It pays to learn from other people's mistakes, so here are some common retirement planning mistakes and possible solutions.
a. Not Budgeting
Spend less than you make. This is the key to saving and a vital habit to learn if you want to achieve your retirement goals.
In this digital age, you have probably gone paperless across the board. The internet is full of apps and spreadsheet templates that will help you track your present-day income and spending.
Knowing exactly how much you have coming in and going out will help you make smarter financial decisions.
b. Not Setting Automatic Transfers
Automatic transfers is a tool you can set up between your checking and retirement accounts, so you do not forget to save.
A good way to do it is to set it to transfer funds on the same day every month to avoid the temptation of spending that money.
c. Not Creating an Emergency Account
Create a separate emergency account with 3-6 months' worth of expenses.
A rainy-day fund will allow you to cover any unforeseen expenses without throwing your retirement plans out of the window.
d. Ignoring Social Security Benefits
Take advantage of social security benefits by creating an account on the SSA website.
Remember to review your account every year to ensure your wages have been reported correctly and better understand your eligibility for future or disability benefits.
e. Not Paying Down Debt
It would be best if you aimed to be debt-free before you reach your 60s.
Not all debt is bad. For instance, borrowing money to start a business.
However, consumer debt such as credit card debt can kill your retirement dreams.
It's not just credit cards, don't go into your non-earning years owing car payments, student loans, mortgage payments and other high-interest debts.
Chapter 5. How Do I Forecast My Retirement Budget?
You need to invest with the end in mind, which is why forecasting a retirement budget is essential when planning for retirement.
Using your current budget as a starting place and then adding/subtracting any expenses you expect to change in retirement is a tried and tested method of achieving a good estimate.
To forecast your retirement budget:
List all your current expenses. Divide them into 3 categories: fixed, variable and mixed
Study each category and take note of adjustments
Allocate a dollar amount to each of the adjustments
Delete items from your list that you'll no longer need post-retirement
Add items to your list that you will want to do/feel will be necessary post-retirement: this includes necessary items as housing and medical in additional to recreational activities like travel and golfing
Make all other adjustments till you arrive at a minimum dollar amount you must have at retirement
Once you have this minimum dollar, it’s as simple as saving and investing to reach that target.
It's really that simple! So, what are you waiting for?
