But to fund all those grand, post-work adventures — or just to pay for the day-to-day expenses you will incur after you leave the workforce — you need to build up your savings. By putting a financial plan in place now, you can relax and enjoy retirement later.
This retirement guide will tell you how to start planning for retirement.
Set retirement goals
If you’re unsure how to plan for retirement, start small. Consider your objectives first to better determine what steps you need to take to achieve them. The following three tips will help you set your unique retirement goals.
Determine your retirement age
When you plan to retire — and how long you have left until then to save, invest, and pay off debts — impacts every step of your retirement planning process. So, before you do anything else, you should decide on the age you’d like to retire.
Envision your desired lifestyle
You work hard now so that you can take it easy in retirement. But how much of that hard-earned money you need to save — and where you should invest it — depends on what you want your golden years to look like.
Do you want to retire in a specific state or country? The cost of living can vary widely between locations.
Do you want to travel? You’re not alone. Many retirees spend more during the first few years of retirement because they go on trips or cross other items off their bucket lists.
How about medical expenses? Do you have long-term health conditions that require you to put more money aside now to cover those future costs?
Think of all the ways your life could change once you finish working, both for better and, sadly, for worse. Prepare for those now, and you’ll be able to afford the retirement you want.
Estimate your expenses in retirement
As a general rule, you need to replace 70% to 90% of your pre-retirement income through savings, investments, and Social Security. So, if you make $70,000 a year now, you’d need somewhere between $49,000 and $63,000 per year to cover your expenses in retirement.
You can use retirement calculators to get a more personalized estimate of your expenses. But these calculators aren’t exact. One might tell you you’re on track to retire, while another might say you’re way behind.
In the end, you should speak with a financial advisor about retirement, if possible. They can take a holistic look at your finances, calculate future expenses, and help you meet retirement goals.
Assess your financial situation
Once you estimate your retirement cost, you can take stock of your current financial situation. Then, you can make a plan to save what you need.
Review income sources
First things first: How much money do you make right now? This can include your salary at your primary place of employment; side earnings, such as gigs, property rents, or investment dividends; and any other form of revenue.
A general rule of thumb is to put aside 10% to 15% of your pre-tax income each year for retirement planning. So, if you make $70,000, you’d save somewhere between $7,000 and $10,500 annually.
Analyze current expenses
Just as important as your income is what you’re spending it on. Looking at your current expenses can help you find costs that will carry over into retirement. But you also may find areas where you can trim away some fat, like excess subscription services. Cutting back there will allow you to save and invest more.
Establish a savings and investment plan
Odds are, you aren’t just saving for retirement at the moment. You may want to buy a house, create an emergency fund, or pay off your credit card debt. And if you’re in your 20s or 30s, saving for retirement may not seem like a top priority.
But now is the best time to establish a savings and investment plan because you can take full advantage of compounding interest, as shown in the table below assuming a hypothetical 10% rate of return on the money you set aside..
|Total value at 67
If you’re establishing a plan in your 40s or 50s, don’t worry! You still have time to reach your retirement goals. You’ll just need to make higher monthly or yearly contributions.
Here’s how you can put your retirement plan into action quickly and efficiently, regardless of your age:
Open a retirement account
401(k) plans: 401(k)s are employer-sponsored retirement accounts, and they’re a great place to start, especially if your employer offers matching contributions. (Basically, this is free money provided by your employer to your savings account, though you typically have to stay with your employer for a set amount of time to keep those contributions.)
Traditional 401(k)s are tax-deferred, so you won’t owe money until you withdraw funds from your account. Those taxes will also depend on your income after retirement, so you’ll probably pay a lower tax rate.
Most importantly, you contribute using pre-tax dollars. This means that your contributions are deducted from your annual income, for tax purposes, which in turn lowers how much income tax you’ll owe — yet another way a 401(k) helps you make the most of your money.
As an employee, you can contribute up to $22,500 each year, or $30,000 if you’re over 50. You and your employer can’t deposit more than $66,000 combined into your account yearly, or $73,500 if you’re over 50.
Traditional Individual Retirement Accounts (IRAs): As with a 401(k), you contribute to a traditional IRA using before-tax dollars. (Again, that’s money you’ve earned, but it’s deducted from the income you report to the government, which saves you money on income taxes.)
Also like a 401(k), you’ll pay taxes when you withdraw money for retirement.
Advantages to a traditional IRA include the fact that anyone can open one — unlike a 401(k), you don’t need a full-time employer to start one. And unlike a Roth IRA (see below), you can open one no matter what your income.
Roth IRAs: Unlike a 401(k) or a traditional IRA, you contribute to a Roth IRA using after-tax dollars — that is, the money you invest is still counted when reporting your annual income (and therefore subject to income tax).
That said, an IRA still lets you save for retirement in a tax-advantaged way. Once the money is in your account, it can grow tax-free, and you won’t owe taxes when you make your withdrawal in retirement. (This assumes you withdraw the money after reaching age 59-1/2, and have had the account open for at least five years — if you withdraw your earnings before those milestones, you’ll pay a 10% penalty and income taxes.)
You can open a Roth IRA so long as you don’t make more than $228,000 in a year as a married couple, or more than $153,000 as a single filer.
For any type of IRA, you can contribute up to $6,500 per year (or $7,500 if you’re 50 or older). And for Traditional IRAs, you’re required to begin taking money out at age 73.
There are a handful of highly specific exceptions and complications, which you can learn about by consulting a financial advisor, or reading the IRS guide to IRAs online.
Simplified employee pension (SEP) IRAs
One more set of acronyms for you: You can open a SEP IRA if you’re a freelancer or a business owner with one or more employees. Any contributions you make to these plans grow tax-deferred, and you can deduct them during tax time.
The contribution limit for employers and the self-employed is $66,000 per year, or 25% of an employee’s compensation, whichever is less. As a business owner, you can also contribute to an employee’s account, but that employee won’t be able to contribute to their own SEP.
Diversify your investment strategy
It’s like they say: Don’t put all your eggs in one basket. That holds especially true for individual retirement accounts because of contribution limits. You’ll likely need to open multiple accounts, like both 401(k) and Roth IRA, to maximize your contributions and meet your retirement goals.
Retirement plans give you access to a range of investments, including stocks, mutual funds, exchange-traded funds, and bonds. When you’re in your 20s and 30s, experts tend to recommend that you can invest more aggressively. This is because you have longer to ride out any fluctuations in the stock market, where you’ll likely earn higher returns over time. Once you’re closer to retirement, experts typically recommend prioritizing safer investments, like bonds, to preserve your nest egg.
With many managed plans, such as those from Fidelity or Vanguard, you can provide your target retirement date, your general risk tolerance, and be matched with a fund where the investment types will change over time to align with your overall goals, without you having to lift a finger (or click a mouse).