Regardless of whether or not we make a plan for retirement, we will inevitably arrive at that age. The question is, will we be prepared, or not? At some point, there will come a time in life when we no longer wish to continue working. This could be due to medical reasons such as illness or disability, or it could be due to the desire to focus on something else such as pursuing a long-lost dream or spending more time with family. Regardless of the reason for wanting to retire, if you don’t have a retirement plan in place, you may not be able to retire. This could put you in a less than desirable situation. For this reason, it is essential to create and stick to a retirement plan.
Longer Lifespans Meet Reduced Social Security Benefits
We now live in a moment where lifespans are steadily increasing due to advances in health care technology, knowledge, and quality. Today’s future retirees can look forward to longer lifespans and retirements than their ancestors. However, these advances come on the heels of another shift, an economic one. Previous generations could look forward to a retirement funded adequately by social security benefits.
However, today, these benefits are no longer sufficient to provide for retirement. It is now up to each individual to create a retirement plan and save for their retirement. This puts us in the situation where it is more complicated than before to save for retirement due to the long-anticipated lifespans, and where we can count on receiving less assistance from social security than previous generations had access to. For these reasons, creating and contributing to a retirement plan has never been more critical.
Start With a Plan
Now that we know the importance of saving for retirement, where do we begin? We begin with a plan, of course! The U.S. Department of Labor recommends that you start by calculating your current net worth. This is the value of all assets minus liabilities. Assets include home equity, investments, savings, and cash. Liabilities include things like credit card debt, mortgage balances, car loans, and student loans.
This number should ideally be positive, but at least for many Americans, it is often negative. However, don’t let this discourage you. The goal here is to create a baseline from which to begin moving towards a positive net worth, and eventually, retirement.
The next step is to determine how much you will need to save to create an income that is equivalent to between 70 and 90 percent of your current salary. It can be helpful to consult an investment advisor during this step. How much will you need to contribute each month to reach this goal by your target retirement date, and can you make those contributions each month? These are the questions you will need to address during the planning process.
You will want to create a budget that allows for monthly retirement contributions to be made at the same time you pay your other bills.
Begin Saving Right Away, and Save Often
It may seem impossible at first to save up enough to produce an income equivalent to 70-90% of your current salary but don’t worry. You will not need to contribute this full amount. The final amount you end up with will be created by things like market growth (which drives up the value of stocks), income (from bonds), dividend payments (from stocks), and the general principle of compounding interest. Compounding interest happens when interest or growth is created by investing gains from previous interest or growth back into the portfolio. The effects of compounding interest are not to be underestimated, and in fact can be quite mind-boggling to contemplate!
Use Employer Retirement Plans or an IRA
If your employer offers a 401(k) plan, consider taking advantage of it up to the maximum annual contribution. If they match your contributions up to a certain amount, all the better! Employer matches your contributions are like free money you get just for making your retirement contributions.
If your employer does not offer a 401(k) plan, or if they do and you would like to invest further towards retirement, you can consider opening an IRA (Individual Retirement Account). There are two types of IRAs, each of which has its tax advantages. Traditional IRA contributions are tax-deductible but taxed upon withdrawal during retirement. Roth IRA contributions are made after taxes and not tax-deductible but will not be taxed at withdrawal. You’ll want to think about which option is best for your needs and personal tax bracket, both now and at retirement.
Diversify Your Portfolio
A retirement account typically contains a portfolio of investments. As with any portfolio, if you put all your finances in one place, that is seldom the best strategy. It is important to diversify across a variety of investment types and individual securities. For example, a typical portfolio might include a variety of different stocks, funds, bonds, and other types of securities. These different types of assets are typically allocated according to what is known as an asset allocation model. Asset allocation models and strategies are the topics of other articles, but the key takeaway here is to diversify your portfolio to fit well with your risk tolerances and financial goals.
Manage Your Mortgage
If you are young and own a home, it is both your biggest asset and your most significant liability. You can leverage both aspects to your advantage. You may want to keep an eye on interest rates. If the market interest rates fall to a point much lower than they were when you took out your mortgage, it could be beneficial to refinance to reduce the amount of interest you pay. This could, in turn, free up that money to invest in your retirement plan. However, if you have outstanding credit card debt, it is generally better to use the extra cash to pay that off first, and then only invest it in your retirement plan after the debt is eliminated. Credit card debt typically comes with high-interest rates and monthly payments. By removing your credit card debt, you save the money wasted paying all that interest. You also free up the cash from your required monthly credit card payments to be used to fund your retirement plan.