A retirement plan is a strategy for accumulating, allocating and distributing your assets at life and death. While that might sound complicated, for most people, it simply comes down to saving, investing and knowing when to start withdrawing from your accounts. We cover the main steps to proper retirement planning and answer some of the most common questions when it comes to saving for retirement below.
Steps to plan for retirement
According to a 2019 Gallup poll, 54% of Americans cite not having enough money for retirement as one of their top financial worries. The best way to combat that is by having a consistent retirement plan in place. Here’s how to create one.
Step 1: How much do I need to retire?
The problem with retirement planning is that it’s hard to know for sure how much you’ll need. Your retirement income needs depend on a lot of factors, including your current financial situation, your cost of living in retirement and how long the money needs to last.
That’s why most people turn to retirement benchmarks to help them determine how much they need to save for retirement.
For example, Fidelity recommends aiming to save an amount equal to your salary by age 30, three times your salary by 40, six times your salary by 50, eight times your salary by 60 and 10 times your salary by 67. They say this is possible if you can:
- Save 15% of your income annually beginning at age 25
- Invest more than 50% on average of your savings in stocks over your lifetime
- Retire at age 67
- Plan to maintain your pre-retirement lifestyle after you retire
Of course, circumstances vary from person to person. If you’re still paying off a mortgage and other debts in retirement, you might need to save more. If you are debt-free and in excellent health, you may be able to get away with saving less.
Step 2: What's the best retirement account for me?
First, you need to decide which type of account you’ll use to save. Saving money is the foundation of a retirement plan, but investments are how you build real wealth. So it’s important to do your homework and choose your investing strategy wisely.
There are several options but here are two of the more common ones:
- 401(k): A 401(k) is an employer-sponsored retirement plan that allows employees to contribute pre-tax money from their paychecks and invest in certain products. Some employers also match employee contributions, up to a certain percentage. Contributions and investment earnings aren’t taxed until you withdraw the money in retirement. For 2020, you can contribute up to $19,500 to a 401(k) plan and an additional $6,500 in catch-up contributions if you’re over 50. Employees of schools, non-profit organizations, and government agencies may have a 403(b) or 457(b) plan instead of a 401(k).
- IRA: If you’ve already maxed out your 401(k) contributions or don’t have access to an employer-sponsored retirement account, an IRA is another option for retirement savings. There are two types of IRAs: traditional and Roth. With a traditional IRA, you may be able to get a tax deduction for your contributions, but the money is taxable when you withdraw it. With a Roth IRA, contributions aren’t deductible, but distributions are tax-free in retirement. For 2020, you can contribute up to $6,000 to an IRA. People aged 50 or older can make an additional catch-up contribution of up to $1,000.
Step 3: What should I invest in?
Once you decide where to save your money, it’s time to decide on your asset allocation, which is how your investments are divided across different asset categories, such as stocks, bonds and cash. Two factors determine how you allocate your investments:
- Risk tolerance. Every investment involves some degree of risk. Stocks tend to fluctuate dramatically in value but have the potential for higher returns. Bonds have more stable values but lower rates of return. Cash is the safest of the three major asset categories, but it has the lowest rate of return. Your tolerance for risk may be aggressive, conservative or somewhere in between.
- Time horizon. Your time horizon is the expected number of years you have to save before retirement. Someone in their 20s or 30s may feel comfortable keeping a larger chunk of their retirement assets in stocks because they have decades to weather the ups and downs of the stock market. On the other hand, an investor in their 60s would likely want less volatile investments because they have a shorter time horizon.
Step 4: Leverage the power of compound interest
Compounding is when the money you make from your investments is reinvested, allowing your savings to grow faster. And compounding is especially powerful in retirement planning because investments in retirement accounts can grow tax-free. The earlier you start saving, the longer your money has to compound.
The sooner you start saving for retirement, the better off you’ll be.
Step 5: Review your performance and rebalance your portfolio
Once a year, set aside some time to review your investment allocation and consider whether it’s still right for your stage in life. This is also a good time to rebalance your portfolio. Over time, investment earnings and losses can tip your portfolio out of balance and away from your original risk profile. Rebalancing adjusts your investments to ensure they align with your intended asset allocation.
Retirement planning isn’t a “set it and forget it” proposition. It's a good idea to check in on your progress occasionally to make sure you’re still on track.
How to approach retirement planning at each age
When it comes to planning for retirement, the earlier you start saving, the better off you’ll be. But no matter where you start, there are steps you can take to boost your retirement savings. Here are some suggestions.
Retirement planning in early career
Make retirement planning a priority from the start. Admittedly, this may be tough when your income is low and you may be paying off student loans or saving for a home or other life goals. But the sooner you start, the better off you’ll be later in life.
Start contributing to an employer-sponsored 401(k), 403(b) or 457(b), if you have access to one at work. Contribute at least enough to max out the employer matching amount to take advantage of this perk.
Retirement planning in mid-career
One of the biggest challenges of retirement planning in mid-career is competing priorities, especially if you’re paying for your children’s education. But it’s important to prioritize saving for retirement at this stage.
If you’re not contributing the maximum possible amount to your employer-sponsored retirement plan, consider increasing your contributions by 1% to 3% each time you get a pay raise. You probably won’t even notice the difference in your paycheck, but the extra savings can really add up over time.
If you’re already contributing the maximum to a 401(k), consider opening an IRA to increase your retirement savings. And remember to check in on your investments regularly to make sure your portfolio is balanced and your asset allocation aligns with your risk tolerance and time horizon.
Retirement planning in late career
When you’re five to 10 years away from retiring, start visualizing the kind of retirement you want. Your idea of a happy retirement may have evolved from the one you envisioned when you were starting out. Do you want to move to a different climate or be closer to family? Will you work part-time or start a business? Is travel a priority?
Getting a clear picture of your retirement lifestyle can help you get an idea of the resources you’ll need. It will also help you determine whether you need to beef up your savings now to get there.
If your savings are a little short, be sure to take advantage of catch-up contributions to your 401(k) and IRA. Look for ways to reduce your spending and pay off debt to reduce the amount of retirement income that will go toward interest payments.
Retirement planning FAQs
When should I start saving for retirement?
Now! It’s never too early to start saving for retirement, and the earlier you start, the more time you’ll have to take advantage of the power of compounding returns.
Should I pay off debt before saving for retirement?
Balancing paying off debt with saving for retirement is a challenge for many people. If you have a lot of high-interest credit card debt, prioritizing debt over retirement may make sense. But if you have a 401(k), contribute at least enough to get the maximum from your employer match. Then make a budget and a plan to pay off your debts as fast as possible. Once your debt is gone, you can redirect the money you were paying to the credit card companies to your retirement savings.
How do I start saving for retirement?
If you have access to an employer-sponsored retirement plan at work, sign up as soon as you’re eligible to participate and aim to save 15% of your salary. If you don’t have a retirement plan at work, open an IRA. Most banks and financial institutions offer IRA accounts.
How much money will I need in retirement?
The amount of money you need in retirement depends on a lot of factors, including your retirement lifestyle and your health. For one benchmark, Fidelity estimates that most people need somewhere between 55% and 80% of their pre-retirement income to maintain their lifestyle in retirement.
Which retirement plan should I get?
If you have access to a 401(k), 403(b) or 457(b) plan through work, definitely take advantage of it. Otherwise, open a traditional or Roth IRA through your bank or financial institution.