For some, the ultimate goal in life is not to work another day once they reach their senior years, which is another way of "retiring on a beach."
Of course, to achieve this, you'd need to have enough money to sustain your lifestyle and support your daily needs. Retirement planning is a valuable tool in this situation.
Retirement planning is an essential aspect of financial planning to ensure a comfortable and secure retirement.
A properly thought-out plan will help you grow your assets, enable you to live out your retirement how you would like, and have sufficient money throughout your golden years.
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What Future Will You be Spending on?
The power of budgeting
A typical financial strategy when determining retirement income is to save and invest enough to replace roughly 70-90% of your pre-retirement income, so if a person’s pre-retirement income is $63,000, they will probably need between $44,000-$57,000 annually for retirement expenses such as vacation trips or home maintenance.
Once you've retired, monthly budgeting will help you finish your retirement savings early enough.
Calculating for inflation
Inflation is when prices of purchasable items and commodities rise, causing currency value to decrease. The inflation rate is the rate at which these prices rise.
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For example, let’s say you save $7 right now to buy two gallons of milk later when it costs $3.50. Still, due to inflation, it will cost $3.80 for one gallon when you use the money later on - there's a good chance this decreased purchasing power can be attributed to inflation.
How Much Should You Save?
How much interest do retirement plans pay?
The annual rate of return is essential in determining how much money will be made when it is withdrawn. This rate of return depends upon the types of investments that are selected and how they are managed.
Over the past ten years, until the end of 2022, Standard & Poor's 500 (S&P 500) has had an average compounded rate of return of 12.6%, including reinvestment of dividends, for 401k accounts.
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From 1970 to 2022, the average annual compounded rate was 10.7%, with the highest single-year return being 61%.
These figures demonstrate that it is possible to create significant wealth over long periods through intelligent investment choices.
Examples of retirement plans available
Below we've listed four standard retirement plans in the United States.
1. Employer-Sponsored Plans
Employer-sponsored retirement plans, such as 401(k) and 403(b) accounts, provide excellent opportunities for young adults looking to save for their future.
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These qualified retirement plans allow you to save a portion of your salary each year tax-free, and employers often have the option to match what you contribute.
For example, invest 3% of your annual income into your 401(k) or 403(b) account. Your employer may match that with an equal amount deposited into it - essentially giving you a bonus on that investment which will compound over time.
For other tax considerations, you should check out the Roth 401(k) options.
2. Traditional Individual Retirement Account (IRA)
Individuals are allowed to save pre-tax dollars for their retirement with the traditional IRA.
By setting aside money before taxes are calculated, investors can reduce their taxable income and benefit from lower tax liability. This proves especially beneficial for those at the cusp of higher tax brackets, as it reduces them to a lower shelf.
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The most significant draw of this investment option is the upfront tax benefit it delivers. Those taking distributions from the account later in life can look forward to being charged taxes at their standard rate.
3. Roth Individual Retirement Account (IRA)
By making contributions with post-tax dollars, the Roth IRA can help avoid a large income tax bite when withdrawals are made at retirement.
However, contribution limits for either type of IRA (Roth or traditional) are set at $6,500 per year or $7,500 if you're over 50.
It’s important to remember that these limits cannot be exceeded, as excess contributions will be taxed at 6 percent every year until they are withdrawn or brought back into compliance.
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4. SIMPLE Individual Retirement Account (IRA)
A SIMPLE IRA, or a Savings Incentive Match Plan for Employees, is an ideal retirement savings vehicle for small business employees.
It works much the same way as a 401(k) does, allowing employees to save money automatically through payroll deductions with the option of an employer matching up to 3% of their annual salary.
Furthermore, the annual contribution limit for a SIMPLE IRA is up to $15,500 in 2023, with catch-up contributions saving you even more if you’re 50 or older - at $19,000 altogether.
What are the Risks and Other Considerations?
Save, save, save!
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In light of the inflation fears and resulting high-interest rates, it is essential for individuals to review their current personal finance goals and develop foresight on how to save more money and spend less.
Diversify
In investing, diversification is critical. By putting your money into a range of assets with varying risk-reward ratios, you lower your overall portfolio risk while keeping the potential for higher returns.
For example, pulling from a basket of stocks from different industries can lower your risk if you decide to invest in stocks. This is because if one sector does poorly in terms of return, it can be cushioned by other investments that are doing better than expected.
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Putting your money into an investment fund also generates long-term returns; you can seek assistance from a financial advisor to determine where you can put your money.
Saving for Retirement: Necessary or Not?
Those who enter retirement without savings face a difficult decision: continue working part-time or drastically reduce their spending.
Even with Social Security income, many retirees will only receive up to half of their pre-retirement income. This makes a living primarily on Social Security a challenge, with an average monthly benefit of $1,509 as of June 2021, and limits lifestyle choices during retirement.
Conclusion
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Retirement planning is ultimately about financial security, so starting early is essential.
It involves setting aside enough money to maintain your current lifestyle while paying off debt or other financial obligations. A solid retirement plan should give you ultimate financial freedom.
