When you stop earning a paycheck and start relying on your retirement savings and investment accounts to cover your living expenses, you can’t afford to wing it or hope for the best. This is where comprehensive retirement planning becomes vital. Being fully retired often means living on a fixed income, and whether that’s here in our wonderful Janesville, WI community or somewhere tropical, one thing is for certain — you will want to invest for a retirement income.
This means planning ahead and putting in the time and effort required for successful retirement investing during your working and earning years. Planning aims to mitigate some of the stress often associated with the ever-popular question, “When can I retire?”
Although there are many reasons why people choose to invest – to build wealth, to make the most of tax advantages, or sometimes to “play” the stock market as a hobby, just to name a few – one of the most common motivations is to establish a reliable income during retirement.
And just like there are any number of intentions for investing for retirement, there are also many different ideas of what actually defines a “reliable income.” For some, it might mean having enough to modestly and comfortably live on. For others, “reliable income” might be the means to fund a dream lifestyle in retirement. No two retirement dreams are identical and therefore there is no one-size-fits-all concept of a reliable income or plans to provide for it.
How to Plan a Solid Retirement
In theory, there are only two keys to successful retirement planning. Step one: Identify your goals of when and how to retire. Step two: Using your goals to determine how much and how aggressively you need to save or invest to achieve them.
In practice, however, formulating a plan to guarantee yourself a reliable income during retirement through investments isn’t quite so simple. It often requires diligence and careful practice, a solid plan, and a financial advisor and/or an investment manager who is well versed on how to help you invest for a reliable income in retirement.
Critical Rules for Successful Retirement Investing
- It’s not too late (or early, for that matter) to begin working on your plans and goals for retirement. Better to have a late start than none at all.
- Understand your employee benefits and use them to their maximum advantage. For example, if your employer offers a retirement plan with the matching option, you should absolutely participate in the plan and contribute at least as much as necessary to take advantage of the full match.
- Choose the best retirement investment plan or plans for your unique financial situation, subject to availability and eligibility, of course. Some popular options include:
- Defined contribution plans: The vast majority of employer-sponsored retirement plans are 401(k)s, a type of defined contribution plan. Employee contributions are limited to $19,500 in 2021, plus $6,500 catch-up contribution for those over age 50. And contributions made directly from an employee’s paycheck are not subject to tax, thereby reducing the employee’s taxable income. (Taxes are paid on 401(k) accounts at the time when withdrawals are made.)
- Individual retirement account (IRA): There are many types of IRAs but the two most common are traditional and Roth. With a traditional IRA, you make your contributions after taxes, but distributions are not normally taxed. If you do not have access to an employer-sponsored 401(k) or similar plan, a traditional IRA is fully tax-deductible. You pay tax on 401(k) monies when you make withdrawals, based on the income bracket you’re in at the time of the withdrawal.
- With a Roth IRA, the contributions are made before tax, but distributions are taxed. Earnings in a Roth IRA grow tax-free, with the added benefit of tax-free withdrawals beginning at age 59 1/2, provided you’ve held the account for at least five years.
- The 2021 individual contribution limit for both traditional and Roth IRAs is $6,000, with a catch-up allowance of $1,000 for those over 50. This limit is collective, meaning if you have more than one IRA you may only contribute up to the limit across all accounts.
- Pension plan: If you’re fortunate enough to be offered a pension, count your blessings! Fewer employers are offering this kind of defined benefit plan, mainly because they’re expensive for companies to fund.
- Pensions usually distribute an annual payout, based on a percentage of your salary and years of service. The beauty of this type of retirement plan is that you can’t outlive your money – your pension is guaranteed for life.
- Annuity: You probably won’t find this kind of retirement plan at work. Guaranteed income annuities require a large investment upfront, but give you a monthly income for as long as you live.
- As far as tax advantages, you buy an annuity after-tax, but then you only pay tax on the earnings.
- They may offer lower returns than other types of investments, but the risk is also much lower, and you’re guaranteed income for life. The longer you live, the more money you’ll receive overtime.
The idea with all of these is not only that you set money aside for your living expenses in retirement when you are no longer collecting a regular paycheck, but also to invest your money so that it has a chance to grow, earn additional income, and compound your investment. In addition, most of these retirement savings vehicles also offer fairly low risk and high tax advantages that often offer benefits during your working and contributing years.
More questions than answers about how to create a solid plan for a reliable retirement income? You are not alone! I encourage you to talk to your advisor or investment manager. And if you have yet to establish a relationship with a trusted advisor, schedule your 15 min complimentary call with an Uncommon Cents Investment advisor. We will have your questions answered by a Certified Financial Planner who specializes in helping people live their best lives in retirement.