Many of us look forward to retirement – the golden years when we will be free from work obligations and able to do what we want with our time.
But to fund all those grand adventures after work—or just to pay for the day-to-day expenses you’ll incur after you leave the workforce—you’ll need to build up your savings. By putting a financial plan in place now, you can relax and enjoy retirement later.
This pension guide tells you how to start planning for retirement.
Set retirement goals
If you’re not sure how to plan for retirement, start small. Think about your goals first to better determine what steps you need to take to achieve them. The following three tips will help you set your unique retirement goals.
Determine your retirement age
When you plan to retire ̵1; and how long you have until then to save, invest and pay off debt – affects every step of your retirement planning process. So before you do anything else, you should decide what age you want to retire.
Imagine your desired lifestyle
You work hard now so you can take it easy in retirement. But how much of that hard-earned cash you need to save—and where to invest it—depends on how you want your golden years to look.
Do you want to retire in a specific country or countries? The cost of living can vary greatly from place to place.
Do you want to travel? You’re not alone. Many retirees spend more in the early years of retirement because they go on trips or cross other items off their bucket list.
What about healthcare costs? Do you have long-term health conditions that require you to put more money aside now to cover future costs?
Think of all the ways your life could change once you’re done with the work, both for the better and, unfortunately, for the worse. Prepare for them now, and you’ll be able to afford the retirement you want.
Calculate your expenses in retirement
As a general rule, you must replace 70% to 90% of your early retirement savings through savings, investments, and Social Security. So if you’re making $70,000 a year now, you’d need somewhere between $49,000 and $63,000 a year to cover your expenses in retirement.
You can use pension calculators to get a more personalized estimate of your expenses. But these calculators are not accurate. One might say you’re about to retire, while another might say you’re way behind.
Ultimately, you should talk to a financial advisor about retirement, if possible. They can take a holistic view of your finances, calculate future expenses and help you reach your retirement goals.
Assess your financial situation
When you estimate your pension cost, you can take stock of your current financial situation. Then you can make a plan to save what you need.
Review sources of income
First things first: How much money are you making right now? This may include your salary at your primary workplace; side income, such as gigs, property rentals or investment dividends; and any other form of income.
A general rule of thumb is to set aside 10% to 15% of your pre-tax income each year for retirement planning. So if you earn $70,000, you would save somewhere between $7,000 and $10,500 annually.
Analyze current expenses
Just as important as your income is what you spend it on. Looking at your current expenses can help you find costs that will carry over into retirement. But you may also find areas where you can trim some fat, such as redundant subscription services. By cutting back there, you can save and invest more.
Create a savings and investment plan
Odds are you’re not just saving for retirement at the moment. Maybe you want to buy a house, create an emergency fund, or pay off your credit card debt. And if you’re in your 20s or 30s, saving for retirement might not seem like a top priority.
But now is the best time to set up a savings and investment plan as you can take full advantage of interest compounding, as shown in the table below assuming a hypothetical 10% return on the money you set aside.
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If you’re setting up a plan in your 40s or 50s, don’t worry! You still have time to reach your retirement goals. You just need to make higher monthly or annual contributions.
This is how you can implement your pension plan quickly and efficiently, regardless of your age:
Open a retirement account
401(k) plans: 401(k)s are employer-sponsored retirement accounts, and they’re a good place to start, especially if your employer offers matching contributions. (Basically, this is free money that your employer provides to your savings account, although you usually have to stay with your employer for a certain amount of time to keep these contributions.)
Traditional 401(k)s are tax-deferred, so you don’t owe money until you withdraw money from your account. These taxes will also depend on your post-retirement income, so you’ll probably pay a lower rate.
The most important thing is that you contribute money before tax. This means your contributions are deducted from your annual income, for tax purposes, which in turn lowers how much income tax you owe — yet another way a 401(k) helps you get the most out of your money.
As an employee, you can contribute up to $22,500 each year, or $30,000 if you’re over 50. You and your employer can put no more than $66,000 into your account together each year, or $73,500 if you’re over 50.
Traditional Individual Retirement Accounts (IRAs): As with a 401(k), you contribute to a traditional IRA using pre-tax dollars. (Again, that’s money you’ve earned, but it’s deducted from the income you report to the government, saving money on income taxes.)
Like a 401(k), you pay taxes when you withdraw money for retirement.
The advantages of a traditional IRA include the fact that anyone can open one—unlike a 401(k), you don’t need a full-time employer to start one. And unlike a Roth IRA (see below), you can open one regardless of your income.
Roth IRAs: Unlike a 401(k) or a traditional IRA, you contribute to a Roth IRA using after-tax dollars — that is, the money you invest is still counted when you report your annual income (and therefore subject to income taxes).
That said, an IRA still allows you to save for retirement in a tax-advantaged way. Once the money is in your account, it can grow tax-free, and you won’t owe tax when you withdraw it in retirement. (This assumes you withdraw the money after you reach age 59-1/2 and have had the account open for at least five years – if you withdraw your earnings before these milestones, you’ll pay a 10% penalty and income tax.)
You can open a Roth IRA as long as you don’t earn more than $228,000 in a year as a married couple, or more than $153,000 as a single filer.
For any type of IRA, you can contribute up to $6,500 per year (or $7,500 if you’re 50 or older). And for traditional IRAs, you have to start withdrawing money at age 73.
There are a handful of very specific exceptions and complications that you can learn about by consulting a financial advisor or reading the IRS Guide to IRAs online.
Simplified employee pension (SEP) IRA
Another set of acronyms for you: You can open a SEP IRA if you’re a freelancer or business owner with one or more employees. Any contributions you make to these plans accrue tax, and you can deduct them at tax time.
The contribution limit for employers and the self-employed is $66,000 per year, or 25% of an employee’s compensation, whichever is lower. As a business owner, you can also contribute to an employee’s account, but the employee will not be able to contribute to their own SEP.
Diversify your investment strategy
It’s like they say: Don’t put all your eggs in one basket. This is especially true for individual retirement accounts due to contribution limits. You will likely need to open multiple accounts, such as both a 401(k) and Roth IRA, to maximize your contributions and meet your retirement goals.
Pension plans give you access to a range of investments, including stocks, mutual funds, exchange-traded funds and bonds. When you’re in your 20s and 30s, experts usually recommend that you can invest more aggressively. This is because you have more time to ride out any fluctuations in the stock market, where you are likely to earn higher returns over time. Once you’re closer to retirement, experts typically recommend prioritizing safer investments, like bonds, to preserve your nest egg.
With many managed plans, such as those from Fidelity or Vanguard, you can set your target retirement date, your general risk tolerance, and be matched with a fund where the investment types will change over time to fit your overall goals, without you having to lift a finger ( or click a mouse).
Tackle high-interest debt
Not all debts are equal. High-interest debt, like credit cards, costs you a lot of money in the long run, especially if you carry a balance.
You can lose more money on interest payments than you would gain from investing the same amount. According to Investopedia.com, the historical average annual return for the Standard & Poor’s 500 (S&P 500) has been 10%. But the average APR for new credit cards is almost 24%. (Even with excellent credit, the best interest rate you can get on a low interest credit card is around 13.7%).
In other words, the cost of borrowing money exceeds the reward of investing money, at least when it comes to credit cards and other high-interest loans. Therefore, it is better that you pay off these debts before investing in the market.
Prioritize paying off debts
You should pay off high-interest debt as soon as possible to minimize the money you lose in interest. Then you can use the money you save to plan for retirement and meet other financial goals.
Making minimum monthly payments drags out your payment process. So pick one debt and start paying more than the minimum every month until you eliminate it. Then move on to your next high-interest debt, and so on, until you’ve paid them all off.
Avoid new high-interest debt
You don’t want to eliminate high-interest debt only to take on more of it. So one of your financial goals should be to build an emergency fund. You can use the money you’ve saved to cover unexpected expenses instead of charging those expenses to credit.
Review and adjust your financial plan
Life inevitably changes, and your retirement plan should change to match. You may go through periods where you cannot save as much as you originally planned. Or you could land a higher-paying job at a company that matches your 401(k) contributions, allowing you to put more aside.
So try to review your financial plan once a year. You can assess whether your retirement savings are on track and, if not, make adjustments to investment and savings rates.
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