Getting the most out of retirement means putting yourself in the best possible financial situation. The best way to do this is with a plan. Tax-efficient retirement planning will put you in prime position to reap the many benefits of retirement.
A major part of any successful financial plan is intelligent investing, and retirement is no different. With fewer people able to rely on pensions each year, investing wisely for retirement has a massive impact on finances during your golden years.
How Much Is Enough?
The answer to this question varies from person to person and is good place to start when deciding how to invest for retirement. There are a number of factors to consider when trying to pin down the amount of retirement savings that will keep you living comfortably.
Will your retirement income need to pay for extensive international travel?
Do you live in an area with a low cost of living?
Also, consider whether you’ll be supporting yourself or a family. What about wealth to pass on to future generations?
It’s clear that the answer to how much money you’ll need in retirement is different for everyone. One method suggests that you aim to have between 70%-85% of your pre-retirement income to maintain your lifestyle. While this could be used as an estimation, it is a generalized approach and doesn’t take into account enough information. For example, this percentage would vary quite a bit depending on what year of your career you’re in.
In attempting to calculate the amount of retirement income you’ll need each year, be sure to consider the following:
Retirement Income: Not Just to Cover Investments
This is the most obvious category for consideration. How accurately can you predict how much money you’ll need every year in retirement? Most Americans need less income in retirement due to paid mortgages and lack of a daily commute. However, it should be noted that everyone’s situation will be different. Those with higher than average medical costs during this stage of life will need a higher level of income to match.
Length of Life
How long you expect to live will also have a big effect on how much money you’ll need to last you through retirement. If you’re very physically healthy and have a history of family members who have lived long lives, you may expect to live into your 90s or beyond. Such a healthy outlook means lower per-year medical costs, but it also means a potentially drastic increase in long-term healthcare costs.
The Future Value of Your Money
It can be a mistake to neglect to factor in inflation when coming up with the amount of money you’ll need in retirement. The additional funds you’ll need to pay for retirement will grow as time passes. It’s important to take this into account when making calculations.
Will your income grow with inflation or is it a truly fixed income?
Where Should You Invest?
There is no shortage of retirement savings accounts to choose from. In fact, the number of available options can be quite overwhelming. Understanding how to make the most of tax-deferred options like IRAs and those that offer tax-free growth like Roth accounts is a must. There is also a wealth of non-tax-advantaged investment options to choose from like money market accounts and real estate investment trusts.
Here’s a breakdown of some of the most common investment choices and how they can help you meet your retirement investment goals.
Options to Consider for Retirement Investment Goals
These are retirement savings accounts provided by an employer. They can be highly beneficial in that employers will often match a percentage of your contributions. For business owners and those who are self-employed, 401k plans are usually not an option.
There are two broad 401k options, the traditional 401k and the Roth 401k. The main benefit of a traditional 401k is that your contributions can be used to lower your annual taxable income. For example, if you make $100,000 in a year and make $15,000 in contributions to your account, your taxable income for that year would only be $85,000. The catch is that the withdrawals you make in retirement will be taxed as normal income tax.
The Roth 401k is different because contributions made to the account are taxed. The benefit of paying taxes on your contributions is that the money in the account can then grow tax-free. You won’t have to pay capital gains tax on the money you grow, and you won’t have to pay income tax on the funds you withdraw in retirement.
Another benefit of 401k plans is that they often have high contribution limits, letting you grow your savings more quickly. A drawback of 401k plans is that they typically have a limited amount of investment options.
Individual Retirement Accounts (IRAs)
IRAs are similar to 401k accounts in that they come in the traditional and Roth varieties. They differ in that an IRA isn’t provided by an employer. For people that have a 401k plan set up by an employer, it’s often wise to also open up an IRA. A unique benefit of IRAs is a wider selection of investment options including mutual funds, bonds, stocks, and exchange-traded funds (ETFs).
One drawback of IRAs is a smaller contribution limit. They also don’t allow for an employer to match contributions. For those that are self-employed and don’t have access to a 401k, this can be an obstacle to saving quickly enough. Fortunately, accounts like SIMPLE and SEP (simplified employee pension) IRAs allow for higher contribution limits.
Unlike IRAs and 401k plans, annuities don’t put any limit on how much you can invest in your retirement per year. They are contracts set up between an insurance company and a policyholder. The insurance company then guarantees payments made out to the policyholder over a determined period of time. The payments can begin immediately or they can be deferred. They can be structured like bonds and provide a fixed return or they can resemble equities and grow at a variable rate.
This type of investment offers tax-deferred growth on capital until distribution, flexibility in investment options, and no limit to the size of the annuity you wish to purchase.
Within your portfolio of stocks, you might want to include some that pay out regular dividends. When you find a healthy company that continues to perform well, they will usually increase their dividends over time. Research shows that in the long run, dividend-paying stocks outperform those that don’t pay dividends.
Dividend income can offer a sizable boost to your retirement investments, but remember that the long-term success of any company is anything but guaranteed. Keep this in mind, but don’t let it keep you from benefiting from potentially big dividend payments.
How Should You Allocate Your Assets?
A well-informed investment plan involves a diversified portfolio. Diversification in your portfolio means that your assets are spread over a few different asset classes. Determining the right asset allocation for your personal retirement goals is of utmost importance. It’s also important to manage your assets throughout your investing life, something you might want to enlist professional guidance for.
Like every other aspect of financial planning, your ideal asset allocation depends entirely on you. There is no formula that applies to every situation. One thing you should consider is what stage of saving you’re in. What’s your timeline?
Many people start out with more aggressive portfolios, placing more of their assets in stocks than in bonds. Then, as their wealth grows and they near retirement, they begin to transfer more of their wealth into bonds for the sake of protecting their retirement funds. Whatever your allocation strategy, remember that diversification is key in giving yourself the best balance of safety and growth.
The Retirement Investment Plan for You
Taking your retirement investment plans seriously is the best thing you can do to make sure you get the most out of retirement. There are so many options when planning how to invest your money that it can seem overwhelming. Relying on social security benefits or a pension to offer support retirement is no longer an option for most of us.
The decisions you must make in planning for retirement are what will determine whether or not your retirement income meets your needs. Make sure you’re taking a well-informed approach. Also, consider seeking professional guidance in planning for your retirement goals.
Your retirement is all about you. Your retirement goals are entirely dependent on how you want to provide for yourself and those around you once you stop working. Whether you want to sell your home and travel the country or maintain as much of your current lifestyle as possible, there’s a retirement investment plan out there for you.
Contact us here to schedule a meeting to discuss your retirement goals.