Investing for retirement
Plan now for an enjoyable tomorrow
Although most of us recognize the importance of sound retirement planning, few of us embrace the nitty-gritty work involved. With thousands of investment possibilities, complex rules governing retirement plans and so on, many people don't even know where to begin. Here is some information to help you get started.
Determine your retirement income needs
A good rule of thumb is that you need approximately 70-80% of your current income to enable you to maintain your current standard of living in retirement. But this is only a general guideline. To determine your specific needs, you may want to estimate your annual retirement expenses.
Use your current expenses as a starting point, but note that your expenses may change dramatically by the time you retire. If you're nearing retirement, the gap between your current expenses and your retirement expenses may be small. If retirement is many years away, the gap may be significant, and projecting your future expenses may be more difficult. Remember to take inflation into account, and keep in mind that your annual expenses may fluctuate throughout retirement.
For instance, if you own a home and are paying a mortgage, your expenses will drop if the mortgage is paid off by the time you retire. Other expenses, such as healthcare-related expenses, may increase in your later retirement years. A realistic estimate of your expenses will tell you about how much annual income you'll need to live comfortably.
Calculate the gap
Once you have estimated your retirement income needs, take stock of your estimated future assets and income. These may come from Social Security, an employer-sponsored retirement plan, a part-time job and other sources. If estimates show that your future assets and income will fall short of what you need, the rest will have to come from additional personal retirement assets.
Figure out how much you'll need to accumulate
By the time you retire, you'll need assets that will provide you with enough income to fill the gap left by your other income sources. But exactly how much is enough? The following questions may help you find the answer:
- At what age do you plan to retire? The younger you retire, the longer your retirement will be, and the more money you'll need to carry you through it.
- What kind of lifestyle do you hope to maintain during your retirement years?
- What is your life expectancy? The longer you live, the more years of retirement you'll have to fund.
- What rate of growth can you expect from your investments now and during retirement? Be conservative when projecting rates of return.
- Do you expect to dip into your principal? If so, you may deplete your investments faster than if you just live off of investment earnings.
Develop a savings and investing plan
When you know roughly how much money you'll need, your next goal is to accumulate that amount through retirement account contributions and investments. First, you'll have to map out an investing plan that works for you. Assume a conservative rate of return (e.g., 5-6%), and determine approximately how much you'll need to contribute every year between now and your retirement to reach your goal.
The next step is to put your plan into action. It's never too early to get started (ideally, begin in your 20s). To the extent possible, you may want to arrange to have a certain amount taken directly from your paycheck and automatically invested in accounts of your choice (e.g., 401(k) plans or other investment accounts).
This arrangement reduces the risk of impulsive or unwise spending that could threaten your plan. If possible, contribute more than you think you'll need to provide yourself a cushion.
Tools to help you get there
With employer-sponsored retirement plans like 401(k)s and 403(b)s, your contributions generally come out of your salary as pre-tax contributions (reducing your current taxable income), and any investment earnings are tax-deferred until they are withdrawn.
Some 401(k), 403(b) and 457(b) plans also allow employees to make after-tax "Roth" contributions. There's no up-front tax advantage, but qualified distributions are entirely free from federal income taxes. In addition, employer-sponsored plans often offer matching contributions, so it is usually a good idea to contribute at least the minimum amount required to receive the full match, if available.
Individual Retirement Accounts (IRAs) also feature tax-deferred investment of earnings. If you are eligible, a Traditional IRA may enable you to lower your current taxable income through deductible contributions. Withdrawals, however, are taxable as ordinary income (except to the extent you've made nondeductible contributions).
Roth IRAs don't permit tax-deductible contributions, but they do allow you to make completely tax-free withdrawals under certain conditions. With both IRA types, you can typically choose from a wide range of investments to fund your IRA.
Annuities are generally funded with after-tax dollars, but their earnings are invested tax-deferred (you pay tax on the portion of distributions that represents earnings). There is also no annual limit on contributions to an annuity.