Retirement is that phase of your life where you can plan to enjoy more and worry less, but for that, you need effective retirement planning. A comfortable retirement is almost inevitably about drawing up the right type of plans both financially as well as personally. The biggest pre-condition to this is that your retirement plans have to start rather early and must be comprehensive enough to last you a lifetime.
While effective retirement planning is almost everybody’s target, realizing it is the biggest challenge. You have to balance a number of factors like timing, extent, total amount and the like. The complexity of creating this plan is unique and I think the biggest challenge is thinking ahead of your times and planning for the inevitability that is most times beyond most of our control.
What Is Retirement Planning?
Retirement planning is the how you get prepared to manage your life, both financially and also in all different aspects of your life, after you become retired. The financial aspect is a lot more important, because it can easily impact all the other parts. Therefore, before you retire, you have to resolve your confusions about pension benefits, and know the sudden medial requirements. Based on your life style, you must also find out how much money you need to become retired.
One aspect that you need to take into consideration long before you get going on your retirement plans is to understand why you need to undertake retirement planning. You must remember that one of the easiest ways to guarantee your financial success is to know how and what resources to tap and when. This will ensure that you can optimize your savings and also anticipate a few of the challenges that you would have to face. That, in itself, also includes a reasoning of why you need this planning.
Uncertainty About Pension Benefits
With a large chunk of Government employees retiring and a significantly lower working population, we constantly hear about diminishing retirement benefits, lower social security returns and the like. In fact, the 2016 report released by the Social Security Board indicates that the number of workers per beneficiary could fall drastically from 3.4 per worker in 2008 to 2.2 by 2035. The only way to deal and overcome this situation is to have a sound retirement plan in place that does not depend unduly on the social security or the pension benefit plan.
This holds true for even those who are pinning too much hope onto a private pension plan. Corporate collapses and bankruptcy by high profile firms could result in significant wealth erosion of many people who are building the resources for future painstakingly. Therefore, when you take matters in your hand and do your own retirement planning, you can always have a lot smoother life when you retire.
Sudden Medical Requirement
None of us can really anticipate the future. While the Social Security system can guarantee a basic minimum amount post retirement, it won’t guarantee your absolute comfort. Now, add to that situation where you need a sudden medical expense which is significantly large. Without proper planning, it can take a turn for worse quite quickly and jeopardize your entire financial needs. Old age almost invariably means additional healthcare costs, but when it’s unplanned, the impact of it is far telling. So it makes sense to do your own planning and keep a significant portion to address these types of necessities in future.
This is perhaps one of the best ways to ensure your entire life savings getting blown away in one go under the impact of a single medical condition. Obtaining a comprehensive health insurance, therefore, becomes a mandatory element of the retirement planning that you undertake.
Need for Contingency Planning
I am sure most of you who are reading this don’t just want to live a comfortable retired life full of benefits they have always wanted but also leave a part of the financial legacy for their loved ones. Without effective planning, not only is this impossible but you also run the risk of becoming a financial liability for them. What follows almost always is a life of bitter ignominy and absolute dejection. But when you have a proper retirement plan in place, you can comfortably allocate funds for various needs and wants without a second thought.
Offers More Flexibility
Another interesting answer to your query, why you need a retirement plan would be that only a comprehensive plan can provide you leeway to remain flexible and adaptive to any changes. If you are not financially secure or have too less capital to depend upon, you would obviously be unsure of any suddenly changes, be it unforeseen suffering or a suddenly location change.
How Much Do I Need for Retirement?
The moment you discuss why you need retirement planning, another question that goes hand in hand with it is how much would you need to save? Frankly, there is no actual number that you could pinpoint to in this context. There are many factors that would have to be taken into consideration, and the final figure would no doubt have to be a happy marriage of all these. It depends on the
- Standard of living that you are targeting for your old age.
- The age that you plan to retire.
- The expenses you might have to bear in terms of medical cost and the like.
When all these factors are taken into consideration, it is surely possible to reach a basic minimum invest target that you can work towards and also aim to fulfill in the longer run. There are several key tasks you need to complete before you can determine what size of the nest egg you’ll need to fund your retirement. These include the following:
As the rule of thumb goes, the estimates should be generally on the higher side, and it would have to close to 80% of your annual salary to continue living the way that you are used to. You could work towards getting a reasonable figure by
- Adding the current market value of all your investments.
- Estimate the rate of return on all the investments thus far.
- Factor in a basic inflation level of 4% for every year.
- If you already have a pension plan provided by the company, consider the amount that you would get at the end of your service and the additional amount that you would have to account for.
- Also, take into consideration the social security benefits that you would be eligible for in your old age.
Perhaps this complex retirement planning can be best explained using an example. Now let’s assume we are planning a retirement programmed for 43-year old Taylor and want to get a realistic savings target for her when she hangs up her boots at roughly 65 years of age.
Taylor currently earns about $50,000, so when she retires she would roughly need close to
- $40,000 of current income levels.
- Current savings that she has equals to $100,000.
- You can safely target that in the period between 43- 65, she would have earned around 6% rate of return.
- If you calculate the Social security benefits that she is entitled to on their website, it would be around $1,100 a month.
Now when you adjust this number to the annual inflation rate that you have taken into consideration, you will see in future terms, you would require closer to $4000 in today’s dollar terms. Therefore, the plan that you are drawing up for your retirement would have to account for $4000-$1100= $3000 difference roughly. When you multiply this by 12, you get a rough estimate for the yearly expenses you would have to account for, closer to $36000 a year.
Let’s assume that both Taylor and her husband have a fairly strong medical background and do not have any hereditary disease risk. Also, they want to leave a part of their savings for their savings for their children and grandchildren, they would then have to plan in a way that they are able to live off primarily on the basis of the returns that they earn from their investment without touching the principal amount. So, if you take an annualized 6% rate of inflation, the retirement fund has to be anywhere north of $500,000. Of course, the calculation that we have done thus far does not account for the taxes that Taylor would have to pay on her investments. If she would be taxed a minimum of 20%, then it would mean to maintain the same level of available income after paying the taxes she would need close to $600,00-700,000 on an average.
Tackling Inflation in Your Retirement Planning
Now, all that planning you are doing has to address one basic necessity, and that is keeping the overall inflation rate under consideration. If you check the economic progress and trend across the US, inflation typically has seen a 2-4% movement on an average. Betting on the higher end of the range, at 4% level, $600,000 in current terms would have to be multiplied by this annualized rate for a minimum of 25-30 years depending on the age of retirement and Taylor’s eventual retirement plan would then look closer to $1.5-2 million.
So the ultimate idea is to assume a retirement planning that can help your investment grow at 10% instead of the 6% rate. This would mean that despite taking into consideration the inflation related adjustments, you would get a net 6% rate of return on your investment ever year. Therefore, a simple solution to reach your target amount would simply mean that you have to keep revisiting this retirement amount for every year and make the necessary adjustment to the overall number.
Of course, all of these assumptions that you would make through the course of your retirement planning, you have to ensure that these inevitabilities like financial turmoil, economic downturn, geopolitical upheaval or sudden financial need. So you need to keep a safety margin to your investment level, and you can coolly breeze through these numerous possibilities. Remember what you are saving is not based on a single day’s calculation and span across decades. While none of us has the magic ball to gaze into the future, the retirement planning has to be fool proof and have to be taken into consideration all these factors very minutely.
This is exactly why you must also consider weighing opportunities of boosting your retirement fund with some part-time job, especially towards the later years. Make your financial projections both realistic and comprehensive and ensure that there is no overlapping of costs in any form.
How to Fund Your Retirement Savings?
One important aspect of your retirement planning is making a secure funding plan. You have to be very sure about the source of funding as that alone can get you access to the right type of resources and help you get to your target levels. There are many sources that you could look at tapping. These include:
1. Monthly Salary:
Whether you are in service or have a business, you surely draw a monthly salary. This, by default, is the largest source of incoming money flow every month and by that extension, also the biggest contributor to your retirement funds. Once you deduct your annual living cost fro the income after tax, you get the amount of income that you can utilise for a variety of savings including your retirement. Take into consideration all the recurring expenses and try to set aside the biggest chunk of savings possible for your retirement plan. US citizens also have the advantage of depositing their retirement savings to an after-tax account or retirement account. This will ensure that the money that is being deposited in your account does not run the risk of getting taxed after retirement as well.
2. Social Security:
The Social Security benefits, no doubt, also form an important element of your entire retirement kitty. You can easily log on to their website and calculate the amount of money that you are entitled to. Therefore based on this calculation, you can easily make projections towards the entire retirement plan. While the social security money on its own won’t be sufficient to meet your retirement needs, it is almost that much of leeway that you can get in the entire retirement fund. This is that additional inflow to your overall fund that you would never mind and always be glad about, however little it might be.
3. Company Sponsored Retirement Plan:
There are some companies that provide a specific retirement plan for their employees. If you have participated n any such plan, the best option is to contact your plan provider and get a realistic idea of how much money you will get at the end of your term. While in itself it might not be sufficient, it can surely be one of the contributors and take off the burden of your complete fund that you need to generate by the time you retire. You can easily add this amount to your overall projected amount and see how much of your living expenses can be covered using this amount at a later date. However, most of these types of retirement plans make payment only once you are 65 years old, so that you must account for. If you quit early, it would not automatically mean you become eligible for it. You will only start getting it once you attain the age you will be eligible for payouts.
While investments will help you in generating a sizable chunk of your retirement plan, you must understand that your investments address several other factors like your housing needs, education for kids, your health and the like. Therefore right at the behest, it becomes very important that you make appropriate allocations and stick to it diligently. If you started saving really late for your eventual retirement, it becomes all the more important to compensate for your investment so that your comfort after retirement is not compromised with. Also, you need to strike a fine balance between covering current living expenses and covering for future expenses and funding needs. Often there are savings that you would like to pass on to your kids and your grandchildren, ensure that you clearly segregate your savings appropriately.
Common Pitfalls That You Must Avoid
That said, we often realize that there are some common mistakes we tend to commit in the process of creating that perfect retirement plan. Because of these mistakes, often the final retirement fund is far short of the actual projected amount, or it might not be as comprehensive as you originally it wanted it to be. There is also a possibility that you become a financial liability for your loved one. The good news is you can avoid all of these eventualities by following some basic investment ethics.
Never Start Late
Though your retirement denotes the last phase of your life, savings for your retirement or your Retirement planning cannot wait for that long and it works in your best interest that you start it rather early in your career. When you start early, your money can grow for a longer period; you have more flexibility in terms of making an adjustment to your retirement fund and also balance other necessary expenses along with this key investment.
The benefit of compounding is huge and the earlier you start, the better you can understand this advantage. Additionally, the more you delay in terms of starting to save, the greater the amount you would have to save every month to reach the desired savings level. This means the pressure on your monthly expenses is huge and could often result in cutting corners or compromising one expense in the interest of another. Also, it is seen that once you start investing later, you tend to take up more risky investment proposition in the interest of getting higher returns. As a result, your associated risk exposure also rises significantly.
Don’t Ignore Inflation
When you are saving for future and working out your retirement plan, one of the biggest problems could be accounting for inflation adjusted price rise. How much would be $100 worth after 25 years is a key question that you cannot wish away and must answer at all cost. Since retirement planning is essentially a long-term goal, it becomes extremely important to apprehend the future challenges and make an allocation for it in your financial plan. It follows pretty much similar planning to that of your health, just like you would exercise and eat healthy today for your better health tomorrow, your financial planning too needs to be healthy today for the desired outcome. Otherwise, the demon of inflation would come to haunt you at the fag end of your life and erode your assets in no time.
Don’t Cash out Your Retirement Fund
Often when faced with an adverse situation, we tend to make rash decisions, and one of those is cashing out your retirement fund to address some immediate necessity. While I am sure that your immediate crisis could be something huge, the fact is your retirement planning would be severely hit if you took out that cash. It would spring out double trouble. On the one hand, you lose out the compounding interest on the already existing kitty and also, on the other hand, the pressure to bump up your savings for old age mounts even higher.
Moreover most times, your retirement funds are tax exempted, and if you let that grow, your relative tax liabilities are much lesser at a later date. But if you encash them mid-way, it would also imply that your tax liabilities increase significantly.
Avoid Delaying Your Health Insurance
Another common mistake that you would see even astute investors commit is expecting one type of savings to service the needs of other. In terms of retirement planning, it can be a very costly mistake. Never confuse your retirement funds as a backup to address any other expense. Remember that you must make a separate allocation for your health insurance. Health issues by its nature could result in huge cost outgo, and the absence of insurance will significantly crank up the pressure on your limited retirement fund. It is for this reason that you must never delay applying for a health insurance. The earlier you apply, the better terms and prospects you have and a lesser burden it would pose on your future expenses.
Retirement Planning Means Balancing the Necessities
Therefore retirement planning is all about balancing necessity with possibility. Whether you are head of a successful firm or a daily wage earner, we all want to guarantee our comfort in our old age, and creating an effective retirement plan is perhaps the best way to go about it. All you need to do is make a realistic assumption of the expenses that you need in say 20-25 years and work diligently towards achieving that goal. Of course, the two key factors you need to account for are inflation and income tax. Remember whatever funds that you set aside, it should meet your long-term targets minus these key cash outgo.