…if you think you’re behind.
by Grace S. Yung, CFP
If you think you’ve gotten a late start in the retirement planning game, don’t worry—you’re not alone. Research shows that there are actually a large number of baby boomers who have not saved enough for retirement—even though the number-one fear of retirees today is running out of money.
Clearly Defining Your Goals
As with anything else, in order to execute a successful financial plan for retirement, you should start out by clearly defining your goals. It isn’t enough to simply state that you “want to retire soon,” as that is much too vague.
Rather, your financial goals should have both a deadline and an amount. This way, you will have a specific objective to strive for, as well as a way to determine whether or not you are on track for achieving it.
To actually define how much you will need to save, you should have an idea of how much your expenses will be in retirement. In other words, how much will you be spending? Here, you will also have to factor in longevity. Today, it is completely realistic to plan for a retirement that lasts 25 to 30 years or more.
Preparing for Emergencies
In getting started with your savings and investments, it is important to have an emergency fund in place. This way, you won’t have to use high-interest credit cards should you need to cover the cost of a high-dollar emergency such as a home maintenance or medical bill that isn’t covered by insurance. Likewise, if you happen to find yourself unemployed, an emergency fund can provide you with the financial cushion needed to pay your living expenses while searching for a new job.
Most financial advisors feel that your emergency fund should ideally have between three and six months’ worth of your living expenses in it. You should keep these funds in a money market fund or a bank savings account that is both safe from market fluctuations and easily
Employer-Sponsored Retirement Plans
If you’re fortunate enough to work for an employer who offers a retirement plan such as a 401(k), you should definitely participate. There are several very good reasons for doing so. First, you can typically defer your contributions to the plan. This means that the income you deposit is not counted as taxable income for that year—essentially allowing you to lower your tax bill. When you participate in an employer’s retirement plan, you should ideally max out your contributions each year, taking advantage of the tax deferral. For 2014, you can contribute up to $17,500.
Next, the growth inside of your retirement account is allowed to grow tax-deferred. This means that funds in the account can compound over time, year after year. This can grow your account much faster than a taxable account due to the drag on your portfolio caused by income or capital gains taxes each year.
When you finally withdraw money from your 401(k) plan, your funds will be taxed as ordinary income. The good news here, however, is that oftentimes people are in a lower income tax bracket at retirement.
Another possible benefit of participating in your employer’s retirement plan is that your employer may also provide “matching” contributions into the account. These are additional deposits, made by your company, that are based on a percentage of the amount that you contribute. This can essentially be thought of as free money.
Today, many companies are also offering Roth 401(k) accounts. With these plans, employees may elect Roth IRA-type treatment for some or all of their retirement-plan contribution, meaning that their contributions are funded with after-tax money. The withdrawals, however, are tax-free once the investor reaches age 59½.
Which IRA Is Right for You?
In order to give your retirement funds a boost, you should also consider opening an Individual Retirement Account, or IRA. Today, there are actually two types of IRA accounts—the “Traditional” and the “Roth.”
With a Traditional IRA, your contributions are usually tax-deductible—but if you are also covered by a retirement plan through your employer, you must meet certain income qualifications. Your funds within a Traditional IRA can grow on a tax-deferred basis, and similar to 401(k) funds, they are not taxed until the time of withdrawal.
Upon reaching age 70½, you are required to begin taking withdrawals from your Traditional IRA account if you haven’t already done so. These are referred to as Required Minimum Withdrawals. At that time, you are also not allowed to make any additional contributions into the account.
2014 Traditional IRA Contribution and Deduction Limits
With a Roth IRA, your contributions into the account are not tax deductible. However, the funds inside of the account are allowed to grow tax-free. In addition, at the time of withdrawal, your funds can come out of the account without being taxed.
Also unlike a Traditional IRA, you are not required to begin taking Roth IRA withdrawals at any particular age, nor must you stop making contributions into the account at age 70½. Likewise, as long as you have earned income (or where contributions qualify for a spousal IRA), you can also continue making contributions to a Roth.
2014 Roth IRA Contribution and Deduction Limits
In 2014, the maximum contribution you can make into either a Traditional or a Roth IRA account is $5,500 if you are age 49 or younger. Those who are 50 or older may contribute an additional $1,000 “catch up” contribution to help increase retirement savings.
Safe Withdrawal Rates for Retirement Income
When it comes time to turn investments into an income stream, it is also essential to ensure a safe rate of withdrawal. Many retirees’ fears about running out of money are due in large part to longer life expectancies that are forcing retirement savings to be stretched farther than ever before.
There are a number of different simulations and calculations for determining whether or not a retiree will have enough money over time, based on various factors. The Monte Carlo simulation, for instance, runs hundreds—or even thousands—of potential outcomes that are based on a person’s portfolio, along with other historical financial data. This analysis results in a bell curve that highlights what will most likely happen, as well as some of the more extreme scenarios that may occur.
With this in mind, it is important to factor in criteria that are not too risky, while at the same time not too conservative, so as to ensure that your retirement funds last as long as possible through the many different types of market environments that could occur.
The “Living Benefits” Income Stream
One way that retirees have provided themselves with a guaranteed stream of retirement income is by purchasing an annuity. These financial vehicles can be set up to provide their holder with income for life—regardless of how long that may be.
In addition, annuities can offer optional “living benefits” such as a guaranteed lifetime withdrawal benefit. This rider allows an annuity holder to withdraw a guaranteed percentage of his or her total premiums each year—regardless of the performance of the underlying market. This can be a nice advantage in a poor market environment.
Generating Added Cash Flow in “Retirement”
Today, many retirees are finding other ways to supplement their Social Security and investment income. Many are leaving their full-time employer and going on to work part-time or on a freelance basis in areas that they’ve always wanted to try, but never had the time to take part in.
For example, some are working with animals or traveling to places they’ve never seen as paid travel guides. Still others are finally getting in touch with their artistic side and making a nice side-income in the process.
Another way that retirees have often been able to supplement their income is through purchasing rental property. In some parts of the country, real estate is a buyer’s market where bargain properties can be purchased and rented for a profit. However, it is important to be sure that the property is in a desirable location and in good condition. If you don’t want to deal with tenants directly, you can typically find property managers who will take care of all the details for you. Just be sure that the property-management fee is low enough to still make the deal profitable.
Taking the Next Step
Saving and preparing for retirement should be a lifelong process—and a regular habit that you can virtually put on “autopilot” by simply budgeting, setting up your savings plans, and paying yourself first.
By having a direct-deposit setup with brokerage or savings accounts, you will be contributing to your portfolio regularly and working toward your ultimate retirement goals.
As you work through your retirement investment plan, it is important to meet with a professional in the financial field who can help you put together a step-by-step plan for achieving your goals. By working together, you will be able to set up a plan that best fits your needs, and then review it along the way in order to make the necessary alterations to ensure it is on track.
Personal finance-related questions may be e-mailed to [email protected]
Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston.