Planning for retirement and having a successful retirement remains one of the biggest financial concerns among Americans today. According to Prudential's 2016 Retirement Preparedness Survey, 49% of respondents cite saving for retirement as their number one financial concern, followed by not having enough money to maintain their lifestyle through retirement at 47%.
Figuring out your retirement options isn’t always easy though. You have to choose a retirement plan that works best for you, know how much you should be investing, select an investment strategy and periodically check your progress. This is likely why many individuals feel “stuck” due to the amount of decisions that need to be made and the potential effects of making a mistake. Three-fourths (74%) of pre-retirees agree that they should be doing more to prepare for retirement, but 40% say they do not know what to do.
Here are a few things you should know to get started and what you can do.
What is a retirement plan?
A retirement plan is a strategy for the accumulation, allocation and distribution of your assets at life and at death. For many, retirement planning simply comes down to how you save, how you invest and how you protect yourself once you’re withdrawing from your accounts.
There are several factors that will go into your retirement plan. Here are some of the most important factors that your financial planner will likely include:
How much money will you need in retirement?
Without this question, it is difficult to know how much money you should have saved and whether or not you’re on track for that goal. How much money you will need in retirement will vary depending on your current lifestyle and in what location you decide to retire. One popular way to find out how much money you will need is by using a retirement benchmark.
Remember, no benchmark is perfect. It is important to pay attention to the assumptions used in the model. JP Morgan Chase assumes an annual pre-retirement contribution of just 5%, but most financial planners would suggest saving closer to the 10 to 15% range.
Fidelity states: “Aim to save at least a total of 15% of your pretax income each year from age 25 to age 67. Together with other steps, it should help ensure that you have enough income to maintain your current lifestyle in retirement.” For some, 15% may seem like a lot, but it does include any matching contributions from your employer as well.
How are the funds allocated?
Looking back at Prudential’s retirement study findings, 71% of pre-retirees said they consider themselves to be prepared to make wise financial decisions, but nearly 2 out of 5 did not know how their assets were allocated or what products they were invested in.
Your retirement assets will usually fall into three main categories: stocks, bonds and cash. How you decide to divide your money between these three areas is called asset allocation and it is one of the most important factors in the investment portion of your financial plan.
The first step to determining the correct investment allocation is by taking a risk-tolerance questionnaire like this one from Vanguard. The questionnaire will give you an idea of how your assets should be allocated based on your goals, how you feel about risk and how much longer you plan on investing.
With these results, you and your financial planner will determine if there are any changes that need to be made, what you should be investing in and determine what type of investor you are: moderate, conservative, aggressive, etc.
You should generally check your investment allocation between one to four times per year or if your allocation surpasses a certain threshold; this is a process called rebalancing.
For example, if you intend on having a portfolio that is 50% stocks and 50% bonds, you may decide to rebalance once every year. This is called a time-only rebalancing strategy. You could also rebalance at the point in which the portfolio exceeds a predetermined level, known as a threshold-only strategy. For example, you would rebalance the portfolio if it exceeds 5% of the target.
Which accounts are you withdrawing from, in what order and how long will they last?
Where you withdraw your money in retirement matters. Generally speaking, most experts recommend pulling from your taxable and Roth accounts before pulling from pretax accounts, like your 401(k) and traditional IRA. Depending on your tax bracket, this should help with keeping your taxable income lower while allowing the pretax plans to continue growing.
After determining which account to withdraw from, your plan should include the amount you can withdraw and how long you can sustain taking out that amount. One typical rule of thumb is to live off of 4% of your total retirement savings. If you can live comfortably off of $40,000 per year in retirement, you would need about $1 million by the time you retire. Your retirement plan, however, should go well beyond the rule of thumb and determine a true withdrawal rate as your situation may be more specific than a general rule.
When are you taking Social Security? And when should you retire?
Your plan should also help determine the age at which you should begin taking Social Security and the age to retire. In most cases, you’ll want to delay taking Social Security as long as you can. Ideally, you should wait until age 70 when you can receive the maximum benefit. You can, however, begin taking Social Security benefits at age 62, but the amount you receive will be permanently reduced.
Types of retirement accounts
A retirement account is a type of investing account which allows the account holder to invest on a tax-advantaged basis. Each plan has a different set of rules around tax treatment, investment selection and withdrawals, just to name a few. The goals of your retirement plan is to save enough to retain your current lifestyle once your typical employment expires or you decide to leave. Below, we have categorized retirement accounts listed by the IRS for simplification.
Most common accounts
- Individual Retirement Arrangements (IRAs)
- 401(k) Plans
- 403(b) Plans
Accounts for business owners/small business employees
- SIMPLE IRA (Savings Incentive Match PLans for Employees)
- SEP Plans (Simplified Employee Pension)
- SARSEP Plans (Salary Reduction Simplified Employee Pension)
- Payroll Deduction IRAs
- Profit-Sharing Plans
- Defined Benefit Plans
- Money Purchase Plans
- Employee Stock Ownership Plans (ESOPs)
- Governmental Plans
- 457 Plans
- 409A Nonqualified Deferred Compensation Plans
How to plan for retirement
Step 1: Don’t wait — start saving now
The sooner you save the better. In fact 42% of current retirees wish they had began saving earlier, Prudential found.
Step 2: Find out where you are and where you want to be
With the use of a financial planner or one of the benchmarks mentioned above, you will need to establish where you are right now financially and where you want to be when you retire. The bulk of your planning should guide you on what to do between those two points.
Step 3: Choose your investing strategy
Once you have determined what your starting point and destination are, you must decide what route you’re going to take to get there. Most risk-tolerance questionnaires will help you determine the asset allocation and from there, you can decide what investments are best.
Step 4: Monitor the plan
”Monitoring you plan makes sure you are on the right path but also provides motivation for you to keep up the actions that are going to help you reach your goal,” said Lauryn Williams, a College Funding and Student Loan Advisor (CFSLA).
Most people tend to focus on macroeconomic events, like a recession, that may adversely affect a retirement plan, but there are personal events that could change your plan significantly as well. Some of these events may include changes in your health, getting married or divorced and having children. Each of those factors can cause you to work longer or retire sooner than expected. Your retirement plan will need to be flexible and accommodate you as your life changes.