What is Retirement Planning?

Creating a retirement plan involves first determining your long-term financial goals and risk tolerance. Then, you start taking steps to reach those goals.

This process can begin at any time during your working life, but the earlier you start, the better.

Developing a retirement plan involves identifying your sources of income, budgeting for expenses, implementing a savings plan, and managing your assets.

By estimating future cash flows, you can determine whether your retirement income goals are realistic.

Needless to say, a retirement plan is not a static document. You will need to review and update it periodically to monitor your progress.

How Retirement Planning Works

Retirement planning is about preparing for a good life when you’re done paying the bills, or at least working full-time. But it’s not just about money.

The non-financial aspects of retirement include lifestyle choices like how you want to spend your time and where you want to live. A comprehensive approach to retirement planning takes all of these areas into account.

Your retirement planning goals will change over time:

• Early in your working life, your contributions to retirement savings may be modest. The benefit is that your investments will grow over 40 years.
• In the middle of your career, your income may be at its highest. Then you can set specific income or asset goals and start taking steps to achieve them.
• When you reach retirement age, you move from the accumulation phase to what managers call the distribution phase. You no longer have to add money to your retirement accounts. Instead, you start to draw down and enjoy the benefits you have accumulated over decades.

How Much Money Do You Need to Retire

Your magic number for a comfortable retirement varies greatly from person to person. But there are some basic rules that can give you some advice on how much you should save.

In the past, people used to say that you needed around $1 million to retire comfortably.

Some experts use the 80% rule. What this means is that you need 80% of your current income to live comfortably after retirement. For example, if you earn $100,000 a year, you would need to save $80,000 a year for about 20 years, for a total of $1.6 million.

Others argue that most of us don’t save enough to meet that standard, and suggest that you should adjust your lifestyle accordingly.

Estimate your expenses

Your expenses after retirement will largely determine that “magic number.”

It’s a good idea to create a retirement budget and estimate your expenses for housing, health insurance, food, clothing, and transportation.

And since you’ll have more time, you should also consider entertainment, hobbies, and travel expenses.

While it can be difficult to give exact amounts, a reasonable estimate can help.

Steps to Retirement Planning

No matter what stage of life you are in, there are some key steps to retirement planning that apply to almost everyone. Here are the most common steps:

• Make a plan: This involves deciding when you want to start saving, when you want to retire, and how much you want to save for your ultimate goal.
• Decide how much you want to put away each month: Using automatic deductions takes the guesswork out of it, keeps you on track, and eliminates the temptation to forget or stop putting money in on your own.
• Choose the right accounts for you: If your employer offers one, invest in a 401(k) or similar account. If your company offers an employer match but you don’t sign up, you’re missing out on free money. Whether your employer matches or not, you’re getting a good tax break.
• Review and adjust your investments periodically: This is especially important after a major event like getting married or having a baby.

Retirement Plans

Tax-advantaged retirement savings plans have become the backbone of long-term savings for Americans.

Depending on your career, you may be eligible for one or more of these plans. Each plan has its own rules and regulations.

Employer-sponsored Plans

Most large companies offer 401(k) plans to their employees. Many nonprofit employers also offer 403(b) plans.

The immediate benefit of these qualified retirement plans is that your employer has the option to match the amount you invest, up to a certain amount.

For example, if you contribute 3% of your annual salary to the plan, your employer can match that amount and deposit it into your retirement account along with your contributions.

You can also contribute more than your employer matches. Some experts recommend contributing as much as 10%.

401(k) Limits

The Internal Revenue Service (IRS) reviews these limits annually.

Participants in a 401(k) or 403(b) plan can contribute up to $23,000 in 2024 ($23,500 in 2025), plus additional employer matching.

Individuals age 50 and older can contribute an additional $7,500 per year in 2024 and 2025 as catch-up contributions. Individuals ages 60 to 63 can contribute up to $11,250 in 2025.

These accounts can yield much higher returns than regular savings accounts (although that doesn’t mean they’re riskier investments).

If it’s a traditional account and not a Roth account, you don’t have to pay taxes on the money until you withdraw it. 

Since your contributions are deducted from your gross income, you will immediately receive a tax break.

Those who are approaching a higher tax bracket should consider contributing enough to reduce their tax bill.

Traditional IRAs

A traditional IRA is similar to a 401(k) plan, but can be opened at most banks or brokerages. It’s primarily for self-employed people and those who don’t have access to a 401(k), but anyone with income can invest in an IRA.

The money you save in an IRA can be deducted from your income for the year, which reduces your taxable income and therefore reduces the amount of tax you pay.

The tax benefits of this type of account are that it’s earned upfront. So when you take money out of the account, it’s taxed at your regular tax rate at the time.

But remember, these funds grow tax-deferred. You won’t be subject to capital gains or dividend taxes on your account balance until you start taking withdrawals.

IRA Limits

The Internal Revenue Service (IRS) has set a limit on how much you can contribute to a traditional Individual Retirement Account (IRA) each year.

The limit for 2024 and 2025 is $7,000. Individuals age 50 and older can contribute an additional $1,000 (total of $8,000) in 2024 and 2025.

Withdrawals must begin at age 73, with the earliest you can start taking withdrawals is age 59½. When you withdraw money, you will be taxed at your regular income tax rate for that year.

Roth Individual Retirement Account (Roth IRA)

A Roth IRA is a type of IRA that is funded with pre-tax money. It is a unique type of IRA that allows you to contribute a small amount of money upfront for a large return in the long run.

A Roth IRA eliminates the immediate tax deduction of a traditional IRA. The money you contribute is taxable in the year it is created.

However, when you withdraw the money, you don’t have to pay taxes on the amount you contributed or the profits you make from the investment.

Starting a Roth IRA early can yield big returns in the long run, even if you don’t have a lot of money to invest at the beginning. 

Remember, the longer your money sits in the retirement account, the more tax-free interest you earn.

Roth Limits

For 2024 and 2025, you can contribute up to $7,000 per year to either a Roth or Traditional IRA, and up to $8,000 if you’re 50 or older.

However, there are additional income limits to Roth accounts. For example,

• Single filers can contribute the full amount only if their annual income is $146,000 or less for the 2024 tax year.
• For 2025, it’s $150,000 or less.
• After that, people with slightly higher incomes can contribute a reduced amount. They can contribute up to $161,000 in 2024 and $165,000 in 2025.

(Note: The income limits are higher for married couples filing jointly!)

Like a 401(k), there are penalties for withdrawing money from a Roth IRA before retirement age. However, there are some notable exceptions that can be useful in emergency situations. 

First of all, you can withdraw the money you invested (not the profits you earned) at any time without penalty.

SIMPLE IRA – Simple Retirement Account for Employees

A SIMPLE IRA is a retirement account designed for employees of small businesses. It is an alternative to a 401(k) plan, which can be expensive to administer.

The plan works in a similar way to a 401(k). Employees can have money automatically deducted from their paychecks and saved, and employers can choose to match it.

The amount that can be contributed is capped at 3% of an employee’s annual salary.

• The maximum amount that can be contributed to a SIMPLE IRA each year is $16,000 in 2024 and $16,500 in 2025.
• In addition, there are $3,500 “catch-up contributions” for employees age 50 and older. This increases their limit to $19,500 in 2024 and $20,000 in 2025.

Retirement Planning Steps

Everyone wants to be comfortable when they retire. Below are some key guidelines to follow to ensure you have a successful retirement at any stage of your life.

Young Adulthood (Ages 21 to 35)

Young adults may not have a lot of money to invest. However, they do have one important thing: time to mature their investments. This is a key factor in saving for retirement, and this concept is called the principle of “compounding.”

Compound interest is a system that allows you to earn interest on your money. This means that the more time you have, the more interest you will earn. 

For example, if you can only put away $50 a month, if you start investing at age 25, that amount will be worth three times more than if you start saving at age 45. This is because of the amazing benefits of “compounding.”

Early Midlife (Ages 36 to 50): Save aggressively

This age range (ages 36 to 50) can be a time of financial stress. Home equity, student loans, insurance premiums, and credit card debt are common.

However, this is the most important stage in planning for retirement to continue saving. When you combine your income growth with the time left to earn interest on investments, these are the best years to “save aggressively.”

Important things to do:

1. Take full advantage of employer matching:

• • If your employer offers a 401(k) matching program, take advantage of it and contribute in full. This is important so you don’t miss out on free money.
  • Try to contribute up to the maximum limit to your 401(k) or Roth IRA. (You can have both at the same time.)

2. Consider tax savings:

• • For those who are not eligible to open a Roth IRA (due to income restrictions), consider a Traditional IRA. Like a 401(k), this account allows you to contribute money with pre-tax earnings, and the assets in the account can be tax-deferred.
  • Use a Roth 401(k): Some employer-sponsored plans offer a Roth option. This way, you can save for retirement with pre-tax money. Unlike a Roth IRA, there are no income limits and you can contribute up to a set annual limit.

3. Don’t forget about life insurance and disability insurance:

• • If for some reason you are no longer able to work or are unable to work, these two types of insurance are essential to ensure that your family can financially support themselves without having to tap into your retirement savings. Protecting your future income is like investing.

Later Midlife (Ages 50 to 65): Take on the Challenge

As you approach retirement, you should shift your investment accounts to a more “safe” style. This is because you don’t want to lose money due to market volatility as you approach retirement. 

Things like government bonds (T-bills) are among the safest, although they offer lower returns than other investments.

This age group (50 to 65) has some advantages. They are more likely to earn more than younger savers and have more money to spend.

Catch-up Contributions

Remember, it’s never too late to start a 401(k) or IRA. The biggest opportunity at this stage of retirement planning is “catch-up contributions.”

• Once you reach age 50, You can contribute an additional $1,000 per year to your Traditional or Roth IRA in 2024 and 2025.
• In addition, you can contribute an additional $7,500 per year to your 401(k) in 2024 and 2025.

Take advantage of this “last chance” to significantly increase your retirement savings.

Other Investments and Final Preparations

Once you have fully funded your tax-advantaged retirement plan (e.g., 401(k), IRA), you can continue to save the rest of your money in other investment options.

New Savings Options

• Certificates of Deposit (CDs),
• Blue-chip stocks,
• Real Estate Investments (such as a vacation home you’ll rent out) are all relatively safe ways to grow your retirement savings.

Social Security and Health

The most important things you should do during this time are:

1. Start learning how much Social Security benefits you’ll get and when you should start taking them. The earliest you can start taking them is age 62, but the full retirement age is age 66. You need to decide when to start taking them wisely.
2. You should start thinking about Long-Term Care Insurance. This insurance will help cover the costs of nursing home or in-home care as you get older.

Warning: If you don’t plan well for unexpected health-related expenses, you can wipe out all the money you’ve saved throughout your life. So don’t neglect this step when you’re approaching retirement.

Other Aspects of Retirement Planning

Planning for retirement is much more than just “how much to save and how much you’ll need.” It’s really about taking a holistic view of your financial situation.

How does your home fit into your retirement plan?

For most Americans, the largest asset they own is their home. So how does it fit into your retirement plan?

While homes were once considered a valuable asset, planners no longer see them as such after the housing market crash. With the rise of home equity loans and home equity line of credit (HELOCs), many homeowners are entering retirement with debt.

The question of whether to sell your house and move to a smaller one after retirement is also a question. If you’re still living in the big house you raised your family in, it could be bigger than you want, and it could be more expensive.

So, in your retirement plan, you need to take an unbiased look at your current home and consider what you want to do with it. This decision can have a huge impact on how much you end up paying!

Estate Planning 

An estate plan is a plan that governs what happens to your assets after you die. This plan should include a “will” that outlines your wishes.

Even before you write a will, you should plan ahead with a trust or other strategy to protect your assets from “inheritance taxes” as much as possible.

Currently, the first $13.61 million of your estate is exempt from inheritance taxes as of 2024 ($13.99 million in 2025). 

However, many people are looking for ways to leave money to their children over time rather than giving them a lump sum.

To avoid losing any inheritance you leave behind to taxes, think about this plan early.

Tax-Friendly Management

When you reach retirement age and start using your savings, taxes become a bigger issue. Withdrawals from most retirement accounts are taxed at ordinary income tax rates.

Here’s why you should consider a Roth IRA or Roth 401(k). Both of these accounts allow you to contribute tax-free and then withdraw money tax-free in retirement.

If you think your taxable income will be higher in the future, a Roth Conversion may make sense.

An accountant or financial planner can best guide you through these tax considerations. Don’t forget to look for ways to reduce your taxes!

Health Insurance

As you get older, medical costs tend to increase. Don’t worry, you can get Medicare, a government-sponsored plan, at a lower cost.

But Medicare alone isn’t enough. That’s why most people buy supplemental insurance policies called Medicare Advantage or Medigap to get the full coverage they need.

There are many insurance options available, and they can be complicated. So it’s a good idea to research your options well in advance of your retirement. Plan early to avoid disappointment.

How to Start a Retirement Plan?

Planning for retirement doesn’t have to be difficult. It’s all about putting aside a little money each month—no matter how small.

One place you can start is with a tax-advantaged savings plan.

• Start a 401(k) plan through your employer.
• Open an IRA through a bank or investment company.

You should also consider talking to a professional, such as a financial planner or investment broker. They can help you get on the right track.

The earlier you start, the better! Because your investments will earn interest over time. More importantly, you’ll earn more interest on that interest. It’s called “Compound Interest,” and it makes your retirement savings grow like a rocket.

Why is retirement planning so important?

A retirement plan helps you set aside enough money to continue living your current lifestyle after you retire.

You may be able to work part-time or occasionally take on odd jobs after you retire. But that income won’t be enough to support your current lifestyle.

And Social Security benefits will only provide a partial amount of support.

That’s why it’s crucial to have a solid, long-term plan to help you retire with financial peace of mind. Don’t hesitate, start planning!

What are the main components of a retirement plan?

The goal of a retirement plan is to save enough money to live comfortably after you retire. There are two main things to keep in mind.

The main thing to think about is how to minimize the taxes you pay on your retirement income. One way to do this is to put money into a Roth account or convert a traditional account to a Roth account before you retire. (This way, you won’t have to pay taxes on withdrawals!)

Estate planning should never be overlooked. Remember, it’s about taking care of yourself and your loved ones.

Also Read: What Is a Savings Plan and How Does It Work?

What can you do if you don’t have a 401(k)?

Don’t worry if you don’t qualify for a 401(k). There are a few options.

Options:

• Open an IRA: You can open an Individual Retirement Account (IRA). However, be aware that the IRA contribution limits are much lower than a 401(k). For example, in 2024, you can only contribute $7,000 to an IRA, but you can contribute up to $23,000 to a 401(k) ($7,000 in 2025 and $23,500 in 2026).
• Solo 401(k): For self-employed people, there is a Solo 401(k). This is a great option.
• Annuity: You can also consider an annuity. However, be aware: these are often difficult to withdraw (illiquid) and have high fees.
• Brokerage Account: Finally, you can put money into a regular investment brokerage account. However, you won’t get the same tax advantages as the accounts mentioned above.

The Bottom Line

Everyone dreams of the day they can finally say goodbye to the workplace. But it costs money to do so. That’s where “retirement planning” comes in.

It doesn’t matter what stage of life you’re in.

Putting a little money aside now means you’ll have less to worry about later.