Retirement planning is a dynamic process. While the goal of creating an adequate financial nest egg remains the same, people may alter their strategies or even their ultimate aims as their situations in life change. The shifting nature of retirement planning can be unsettling at times. Individuals may become fearful when they think they are not on the right track or frustrated if they are unsure that they have made the right moves.
Ultimately, retirement planning starts with thinking critically about retirement goals and then creating a plan of how to reach them. Then, individuals check in periodically with their goals and strategies to make necessary changes. Approaching the entire process systematically can relieve much of the anxiety that individuals might feel. At the beginning and during the reassessment process, individuals should address the same key issues, including:
1. Retirement budget
Creating a retirement budget can be extremely difficult. However, without at least a general idea of your financial needs, creating a strategic plan will prove impossible. Individuals should be realistic about their likely retirement spending to make sure they do not find themselves in financial difficulties down the road.
People sometimes assume that they will spend less in retirement than they do while working, but this is often untrue, especially when they still have a mortgage or other debt payments to make. Medical expenses can also drive up spending quite quickly. In addition, many new retirees spend a significant amount of money traveling and crossing other items off their bucket list.
This sort of behavior is not bad, but it needs to be accounted for in a budget. Often, individuals end up spending as much in retirement as they did before, so it can be prudent to set goals high in the beginning rather than trying to play catch-up down the line.
2. Time horizon
Thinking critically about your savings strategy involves accounting for the amount of time left before retirement. Time horizon often has a direct effect on one’s risk tolerance. Most people choose to be risky with their investments when they are younger. Since they will have plenty of time to recover, people can care less about market volatility.
However, the situation changes as people get closer to retirement. With only a few years before retiring, a market downturn could force people to work longer or lower their retirement budget. At the same time, people still need to aim for some sort of growth as they get close to retirement and even after they retire to maintain purchasing power given inflation rates. Individuals always need to consider their investment decisions in the context of their overall time horizon.
3. Risk tolerance
While time horizon has some impact on risk tolerance, individuals also need to think about their personal comfort with risky investments. Accepting more risk provides more room for investments to growth, but larger losses are also possible.
Some people do not deal well emotionally with the numbers in their accounts when the market is down and regular variations may cause them to make poor decisions. If this is the case, you may want to reduce your overall risk level to avoid having an emotional reaction. People should always feel comfortable with their portfolio risk and understand what it means to invest.
All investments involve risk, but some are riskier than others. Accepting some level of risk is usually necessary to meet goals, but individuals have a lot of control over how they approach investments. Understanding your baseline risk tolerance, which may change over time, is important for making educated decisions.
4. Tax planning
Most Americans underestimate the importance and impact of taxes in retirement. This is largely because we are all told repeatedly that we will be in a lower tax bracket in retirement, so the best thing to do is to maximize contributions to tax-deferred accounts such as 401ks and 403bs.
However, most retirees lose their largest tax deductions in retirement and only utilize the standard deduction. As a result, they may find themselves in a higher than expected tax bracket. They may also be surprised to learn that up to 85 percent of their Social Security income will be taxable every year. Additionally, with traditional retirement accounts like a 401(k) or IRA, individuals will pay taxes on every dollar they withdraw in retirement.
By contrast, since Roth accounts are funded with post-tax money, qualified withdrawals from them are not taxed. Individuals can use these different structures to their advantage. For example, converting tax-deferred holdings in 401ks , 403bs and IRAs to tax-free status over several years through a disciplined Roth conversion process is a powerful retirement planning strategy. It can result in avoiding taxes on your Social Security every year—a potentially very big difference in your retirement budget over time.
Tax planning early in the process is important, as it can help people be more strategic with the types of accounts they open and fund. A strategy that only focuses on building up the balances in tax-deferred accounts will leave the retiree susceptible to the full impact of any and all tax increases that may come in the future. Given the country’s financial condition and rapidly aging population, the odds of seeing significant increases in taxes in the future is, unfortunately, very high.
Also, tax planning helps people be realistic with how much they want to save. Once individuals have an ultimate savings goal and a timeframe, they can start to think about the rate of return they would need to stay on track. Importantly, this needs to be an after-tax rate to be realistic. If the after-tax rate is too high, individuals need to figure out a new strategy.
5. Estate planning
People do not always associate retirement planning with estate planning, often because the latter seems to be more for very wealthy people. However, everyone needs some sort of estate plan to ensure proper insurance coverage and makes sure everything is in order in the event of unanticipated death. In addition, most people—even those with more modest estates—look forward to leaving behind a legacy for their loved ones.
For most younger individuals, estate planning consists largely of securing life insurance, but it also important to get together key documents and provide guidance for dividing up assets. While thinking about these issues can prove difficult, forcing grieving loved ones to work with the courts to settle asset allocation is not a good option.
For most people, a will, and a durable power of attorney, and a healthcare power of attorney document will protect both the estate owners and the beneficiaries from costly delays and complicated problems. With these documents in order, loved ones can sidestep the lengthy probate process and also save money. Furthermore, the documents ensure that everything is divided as intended rather than as a court decides.