What Is Retirement Planning?

Retirement planning establishes retirement income goals and the actions and decisions needed to achieve them. It includes identifying income sources, assessing expenses, implementing a savings program, and managing assets and risks. Future cash flows are estimated to determine whether the retirement income goal will be achieved. Some retirement plans differ depending on whether you are in, for example, the United States or Canada, which has its own system of workplace-sponsored plans.

In the simplest sense, retirement planning means preparing for life after paid work ends—not only financially, but in every aspect of life. Nonfinancial considerations include lifestyle choices such as how to spend time in retirement, where to live, when to stop working entirely, and so on. A holistic approach to retirement planning considers all these areas.

The emphasis placed on retirement planning changes at different stages of life. Early in a person's working life, it means setting aside enough money for retirement. In midcareer, it may also include establishing specific income or asset goals and taking steps to achieve them.

Once you reach retirement age, you move from asset accumulation to what planners call the distribution phase. You are no longer paying in; instead, decades of saving are paying off.

Retirement Planning Goals

Remember that retirement planning begins long before you retire: the earlier, the better. Your “magic number,” the amount you need to retire comfortably, is highly individual, but numerous rules of thumb can give you an idea of how much to save.

 

Employer-Sponsored Plans

Young adults should take advantage of employer-sponsored 401(k) or 403(b) plans. An initial benefit of these qualified retirement plans is that your employer has the option to match your contributions up to a certain amount. For example, if you contribute 3% of your annual income to your plan account, your employer may match it by depositing an equivalent amount into your retirement account, essentially giving you a 3% bonus that grows over the years. However, you can and should contribute more than the amount needed to earn the employer match; some experts recommend more than 10%. For tax year 2022, participants under age 50 can contribute up to $20,500 of their earnings to a 401(k) or 403(b), some of which may be matched additionally by an employer. This amount remains unchanged for 2022. Participants over age 50 can contribute an additional $6,500 each year as a catch-up contribution. 5 Additional benefits of 401(k) plans include earning a higher rate of return than a savings account, although the investments are not risk-free. Funds in the account are also not subject to income tax until withdrawn. Because contributions are deducted from gross income, you receive an immediate tax break. People on the edge of a higher tax bracket might consider contributing enough to reduce their tax liability.  

Roth IRA

Other tax-advantaged retirement savings accounts include the traditional individual retirement account (IRA) and the Roth IRA. A Roth IRA, funded with after-tax dollars, can be an excellent tool for young adults. This eliminates the immediate tax deduction but avoids a more significant income tax bite when the money is withdrawn in retirement. Starting a Roth IRA early can pay off over the long term, even if you initially have little money to invest. Remember: the longer money stays in a retirement account, the more tax-free interest it earns.

Roth IRAs have some limitations. The contribution limit for either type of IRA, Roth or traditional, is $6,000 per year, or $7,000 if you are over age 50. A Roth also has income limits: a single taxpayer can contribute the full amount only if they earn $125,000 or less annually for tax year 2021, or $129,000 in 2022. Above that, smaller contributions are permitted up to annual income of $140,000 in 2021 and $144,000 in 2022. Income limits are higher for married couples filing jointly. 7 2

Like a 401(k), a Roth IRA has certain penalties for withdrawing money before retirement age. However, some notable exceptions can be very useful for younger people or in an emergency. First, you can always withdraw your original invested principal without a penalty. Second, you can withdraw funds for certain education expenses, a first home purchase, healthcare expenses, and disability-related costs.

Once you establish a retirement account, the question is how to allocate the funds. If the stock market feels intimidating, consider investing in an index fund that requires little maintenance because it simply mirrors a stock market index such as the Standard & Poor's 500. Target-date funds are also designed to adjust and diversify assets automatically over time based on your target retirement age.

 

Other Aspects of Retirement Saving

• Before age 30, you may not have much spare money to invest, but you have time. That means even modest savings or investments can be left to grow. Compound interest allows interest to earn interest, and the more time you have, the more interest you earn. Even if you can save only $50 a month, it will be worth three times as much if you invest at age 25 as if you wait until 45 to start. You may be able to invest more money later, but you can never recover lost time.
• After age 30, certain financial pressures often enter our lives, including mortgages, student loans, insurance premiums, and credit card debt. Even so, it is essential to keep saving at this stage of retirement planning. The combination of higher earnings and the time you still have to invest and earn interest makes these some of the best years for aggressive saving. You can take advantage of a combination of employer-provided 401(k) programs. You should also try to maximize contributions to a 401(k) or Roth IRA; you can have both at the same time. If you are not eligible for a Roth IRA, consider a traditional IRA. Like your 401(k), it is funded with pretax dollars, and its assets grow tax-deferred.
• At this stage, do not forget life and disability insurance.

 

As the years pass, investing usually becomes more conservative. However, paying off certain expenses at this point—mortgages, student loans, credit card debt, and so on—may leave you with more disposable income to invest. It is never too late to establish and contribute to a 401(k) or IRA. One benefit of this stage of retirement planning is catch-up contributions.

For people who have maxed out tax-advantaged retirement savings options, other investments can be considered. Certificates of deposit (CDs), blue-chip stocks, or certain real estate investments, such as a vacation rental home, may be reasonably safe ways to increase savings.

You can also begin to estimate your Social Security benefits and the age at which it makes sense to start receiving them. Eligibility for early benefits begins at age 62, while the retirement age for full benefits is 66.

This is also the time to explore [long-term care insurance], which can help cover nursing home or home care costs if you need them in old age. Without adequate planning, healthcare-related expenses, especially unexpected ones, can devastate your savings.