Did you know that humans have longer life expectancy now more than ever? We are now living 26 years longer than people were in the 1950s.
Essentially, that means that if you are 50 years old today, you are only 24 years old! And perhaps, the first person to reach 1,000 years is already alive today.
That now brings us to the topic of retirement and how important it is to prepare for it today because, well, a longer life does not necessarily mean a better quality of life. How many times have we heard stories of elderly people living on the street, or former professional athletes who were once millionaires now living in a friend’s basement because they were unable to save money for retirement?
Planning for retirement is a vital part of financial planning. It ensures you a more financially independent lifestyle in the future. This article aims to guide you in planning for when that day comes so you can live comfortably long after you have stopped working.
Why is retirement planning important?
An effective retirement plan means should be a combination of financial and personal planning instead of just concentrating on your finances alone.
Personal planning establishes your satisfaction during retirement. Financial planning, on the other hand, lets you wisely budget your income and expenses based on your plan.
Personal planning lets you determine how you want to spend your retirement. With an idea of how your retirement should be, you will know what your financial needs are. For instance, you might want to travel the whole world after you retire as it is something you are not able to do while working. Or you may want to volunteer at a charitable institution.
However, you will also have to think about your lifestyle preference, and this is where financial planning can help since it will assist you in creating a fund for retirement.
Here are some of the reasons why retirement planning is important.
- Life expectancy is ever-increasing.
- You cannot work forever.
- You need to prepare for medical emergencies.
- Retirement is the time to complete your bucket list.
- You cannot rely solely on pension.
- You cannot, and should not, depend on your children.
It is important to start planning and investing in retirement so you can live a peaceful and independent life later on.
1. Live a stress-free life
When you start planning for your retirement today, you will not feel as much stress today and during retirement, because you know you will be ready. Go for investments that earn regular income during retirement. Remember, retirement is the time where you should enjoy all the benefits of what you are working hard for right now.
2. Tax benefits
Planning your retirement also has some tax benefits. Roth IRAs and Roth 401(k) plans are retirement accounts for tax-free investing. The benefits will come when you reach 59 years and six months old in a traditional Roth IRA, at which point you can start withdrawing your money.
A Roth 401(k), on the other hand, is a tax-free retirement savings plan offered by employers. If you are self-employed, you can get a solo Roth 401(k). You can withdraw your money tax-free after you retire.
3. Let the money work for you
You work to earn money, but you cannot work forever. Retirement is the time to switch roles by letting the money work for you by investing in various asset classes towards the future. Make sure you have a diversified portfolio that can generate income for you regardless of the economic cycle.
4. Beat inflation
Investing in your retirement helps you earn substantial returns that beat inflation. This would not be possible if you merely place your money in a savings account.
How much money do you need to set aside for retirement?
It is important to think about how much things will cost by the time you reach the age of 60. For now, we do not know exactly what those prices will be. You can base them on the average inflation rate in the United States. Over the last century, the average inflation rate in the country was 3.22%. You need to expect higher prices by the time you retire.
You will need to consider your everyday expenses, like food, utilities, and medical. Keep in mind that some of the heavy expenses you have today will probably no longer exist by then, like your kids’ education and mortgage.
Then, add all income you might receive after retirement, including pension, social security, rental income if any, and others. Match these with your future expenses so you can get a better idea of what you will need to put aside each year before you retire.
1. Understand your time horizon
How old you are now and your expected retirement age can build the initial framework of a good retirement plan. If your retirement age is still far away, you can take higher risks. Place a majority of your investments in riskier assets, like stocks. Stocks normally outperform other securities over long periods, which is suited for younger investors.
When you get older, your focus should be on preserving your capital. Invest more on the much safer bond, which gives lower returns but is less of a risk.
2. Compute after-tax rate on investment returns
Once you figure out the expected time horizon, calculate the after-tax real rate of return so you can assess the viability of the investments returning the needed income. A required rate of return of more than 10% before taxes is not a realistic expectation. As you get older, this return threshold diminishes since low-risk retirement investments are usually composed of low-returning fixed income securities.
Most investment returns are taxable, so you need to calculate the actual rate of return after taxes.
3. Evaluate your tolerance for risk against your investment goals
Perhaps the most crucial step in retirement planning is assessing your risk tolerance versus your return objectives. Know how much risk you can take to meet your goals. Talk about this with your family members and financial advisor. You need to be long-term “greedy” and not bail out on your investments at first signs of trouble.
4. Be on top of estate planning
Estate planning is also a major step in a sound retirement strategy. It often requires expert advice from professionals like accountants and lawyers. Carefully outline your plan to avoid expensive probate processes in the future.
Whether you want to retire at the age of 40 or 70, creating a comprehensive retirement plan is a necessity. The challenge here is to strike a balance between realistic earning expectations and a desired standard of living.
The best solution for this is to create an adaptable investment portfolio that you can regularly update to keep up with the volatility of the market and your retirement goals.