When it comes to planning for the future, most people think of retirement. Retirement planning is important because it allows you to do the things that you were unable to do while workingâ’travel, start a business, go back to school, be closer to family, or simply relax. Because retirement is such an important phase in your life, careful planning is a must.
If retirement seems like it is a lifetime away, planning for how youâll spend that time may Â be difficult. But one thing is certain: youâll need to have money in retirement. If you donât plan on working in retirement, where will this money come from? Most people have three sources of income that work together to fund retirement: Social Security, pensions, and personal savings.
Retirement Planning Problems
Even with three potential income streams there are some problems to consider. First, we arenât certain what the future holds for Social Security. Even in the best-case scenario where you receive your full Social Security benefits, the average person only receives 40% of their pre-retirement income. That can certainly help, but with increased costs on things like health care in retirement that money doesn’t go very far.
The next problem has to do with pensions. These employer-sponsored plans not very common today, and even if you are lucky enough to receive a pension benefit, the amount you receive in retirement will likely only supplement around 25% of your pre-retirement income. Younger generations have all but written off pensions as a source of retirement income, so if you have one, count your lucky stars.
With all of the uncertainty and limited payouts of Social Security and pension plans youâre left with finding ways to save some of your current income for retirement. Thankfully, the government realizes the importance of saving for retirement, so they have created tax incentives to encourage you to save for retirement. The problem is that most people simply aren’t saving enough for retirement.
Time is Your Greatest Asset
The most important component of retirement savings is to start as soon as you can. The power of compound interest requires time to work its magic, so the more time you have, the more your money will grow. If you have a 401(k) plan at work or a traditional IRA, begin saving as much as you can, even if it is only fifty dollars a month. Every little bit helps. In addition to saving money for retirement, by making these contributions youâll also be reducing your taxable income today. That means less money in Uncle Samâs pocket and more for you when you retire.
In addition to the common pre-tax plans like a 401(k) or traditional IRA, you should also consider a Roth IRA. While you donât receive an immediate tax deduction from contributions into a Roth, the benefit here is that your money will grow tax-deferred and can be withdrawn in retirement tax free.
Investing for Retirement
Aside from starting early, the biggest obstacle in saving for retirement comes down to the investments. Where should you invest? How do you know if your investments are appropriate? Investing doesnât have to be complicated as long as you follow the golden ruleâ’donât put all of your eggs into one basket. Youâve probably heard that before, but it is worth mentioning again. As long as you spread your investments out across many investment types and asset classes you will maximize your returns while minimizing risk. There’s no way to completely eliminate risk, but diversification works. Take a look at how diversification generated positive returns during the “lost decade” of investing.
If you are primarily saving in a retirement plan through your employer, check to see if your plan offers any asset allocation investment funds. These are funds that automatically invest your money in a way that is appropriate for your age or investment objective. If you do a lot of investing on your own and arenât comfortable making any drastic changes, you may want to seek professional help to ensure youâre doing whatâs best. Working with a financial planner can help you make the most of your current investments and work with you to create a plan to reach your retirement goals.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.