There comes a point in all of our lives where the prospect of retirement appears like a speck on the horizon. It is still a ways off but you can see it coming. Likely, you are in your prime earning years and have 10-20 years until retirement. For some, this is very exciting as it means that years of hard work and prudent financial planning are beginning to pay off. For others, the idea of retirement is very unsettling, and the future is more uncertain. Thankfully, even if you have not given much thought to planning for your retirement, there are things that you can do now to put yourself in a good position when the time comes.
Needs, Wants, and Maybe’s
By this point in your life you probably have a pretty good idea of what your income needs are every month. You also likely have at least an idea of the things that you want to do when you retire and the things that are more of an aspirational goal or a “maybe”. If you have not already, a great place to start is by putting those numbers on paper. Begin by writing out your monthly budget specifically regarding your necessary expenses. Then, subtract the expenses that will end when you retire (e.g. mortgage payment, office rental, commuting costs, etc.) and add in the expenses that will begin when you retire (e.g travel, buying a cottage, charitable gifting, etc.). If you are planning on retiring prior to turning 65 years old, make sure that you include the cost of private health insurance into your monthly retirement budget.
The point of this exercise is two-fold in its usefulness. First of all, by putting these numbers on paper, you can quickly see what it will take financially to meet your bare necessities and in doing so help you to see which of your “want’s and maybe’s” are attainable. Secondly, this exercise gives you a goal to hit. It takes away the ambiguity of your future retirement and makes it a far less nebulous concept. Basically, it makes retirement real and not just an idea. At this point it is also important to remember that your retirement plan is a living, breathing document and nothing is set in stone. If it looks a little bleak right now, don’t sweat it! With a little time and diligent planning, your situation can change dramatically.
Sources of Income
Once you have put to paper your income needs, wants and maybe’s, you should begin determining where your income will come from during retirement. Perhaps the most obvious source of income will be social security. What is less obvious is when to start claiming social security, if it is worth waiting to full retirement age, and how much monthly income you will be receiving in social security? To answer these questions, a great place to start is on the Social Security Administration’s website where you can create an account and get an estimate of your monthly payment. The estimate will also show you what your monthly payment will be at different start dates. Check out SSA.gov and click on Sign In/Up to learn more! If you have further questions, let us know and we would be happy to help!
Another important source of income to consider is your retirement accounts. By the time you withdraw from these accounts, you will have worked a lifetime to accumulate them. Therefore, it is of the utmost importance that you have a strategy when withdrawing from these accounts to fund your retirement goals. This also makes how and where you invest prior to retirement important.
When pulling money from your retirement accounts it is always good to have options. The only way to ensure that you have options is by saving intentionally now, prior to your eventual retirement. While this can get very detailed, for now let’s just focus on the two main “buckets” that you are likely to draw from in retirement.
The first bucket that should be available to you in retirement are “pre-tax” dollars or money that you invested prior to paying taxes on them. The most well-known example of this type of retirement investment is a company 401(k) plan. In a 401(k), your contributions are taken directly from your pay and deposited into your account. This means that when you withdraw funds from your 401(k) in retirement, you will have to pay taxes on the full amount of your withdrawal. For some, this is a huge benefit as they are often in a lower tax bracket in retirement than when they were working full time. For others this can be a burden if they are already facing a large tax payment at the end of the year. This can also have an adverse effect during times of volatility in the market if you have a need for a fixed income from your account.
On the flip side, the second bucket that should be available to you in retirement are your “after-tax” dollars or money that you already paid taxes on prior to investing. The best example for this type of account is a Roth IRA. In a Roth IRA, your contributions are made after you receive your paycheck. This is an individual account which means that you open the account and make your contributions, not your employer. The exception to this rule is a Roth 401(k) which some employers offer as an additional option to their employee retirement plan.
The benefit of having this bucket in place is that contributions grow, and can be withdrawn, completely tax free in retirement (which the IRS says is age 59 and a half). This can be a huge benefit if you find yourself in a situation where you require income but want to avoid taxes. In addition, this can be a better place to withdraw money during times of market volatility as you will not need to take out additional funds to cover your tax withholdings when the market is at a low point.
When it comes to how much you should contribute and to which account, we are here to help! The answer varies person to person and is dependent on the needs, wants and maybe’s that you established before. If you would like to see an example retirement income plan click here to complete our online questionnaire and type “Example Plan” in the comments section.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the
account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for
5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.