Retirement Planning

August 4, 2017 / Robert Dowd

Saving for Retirement Does Not Have to Be Complicated

Saving for retirement may be one of the most important decisions you do with your money, which can be very intimidating.  There are many questions that will run through your head, such as, why should I save? When should I start savings?  How much will I need in retirement?  What accounts are right for me?  How much do I need to know about investing?  All of which are reasonable questions one could ask to be well prepared and on track for the journey towards your goal of retirement. 

Why Should I Save?

The corporate world has transitioned from pension plans to defined contribution plans, such as 401(k)s.  In the 1980s, approximately 60 percent of employers offered employee pension plans.  Today, only 4% of employers offer any type of pension plan to employees.  During those 37 years, the responsibility of saving for retirement has transferred from the employer to the employee.  So, it is imperative that employees take initiative and fund their retirement future!

While Social Security can be a source of retirement income, that should not be your only source.  For 2017, the maximum Social Security benefit an individual can receive is approximately $32,250 a year, and the average benefit is approximately $16,000 a year.  Maintaining this as your only financial resource will run the risk of being unable to afford living necessities.

When Should I Start Saving?

The short answer is, the sooner, the better!  The table below highlights the power of compounding and starting early.  Molly (age 25) and Zack (age 35) start saving $500 a month into their retirement accounts until they turn 65.  Each earns a 5% annual rate of return.  When Molly turns 65, she has contributed $240,000, while Zack has contributed $180,000.  She has only contributed 25 percent more than Zack, but 10 extra years of compounding brought her investment total up to $763,010, compared to Zack’s $416,129. 

How Much Will I Need In Retirement?

There are several variables that can affect your retirement income needs, such as the lifestyle, retirement date, and other income sources you may have during retirement.  Below are a few factors to consider when planning for retirement: 

  • Duration: Thirty years is a good estimate for time spent in retirement. Financial Planners will use the industry standard for life expectancy of 90 years of age.  With modern medical advances and life expectancy growing, a duration of thirty years or age ninety are good benchmarks. 
  • Expenses: If you do not have a budget now, work to establish one before retirement. Focus on fixed and discretionary expenses to better understand what you will need.  No matter how you are spending your retirement, having a ballpark number will determine whether you need to save more, retire later, or are on track.
  • Healthcare Costs: The landscape is rapidly changing and it is difficult to reliably predict the future of health care costs. Current market data suggests healthcare costs have been and may continue to rise at a pace of 6.5% annually. Total healthcare costs for a couple over a 25-year retirement are estimated around $250,000. This would represent any care, coverage or gap plans used to supplement anything not covered by Medicare. 

What Accounts Are Right For Me?

There are a multiple of savings vehicles available and below is a list of accounts that can help you achieve your retirement goals:

  • 401(k) & 403(b) – Both are retirement savings plans sponsored by an employer. Tax deferred retirement accounts that are typically funded with pretax dollars.  Withdraws are taxed at the ordinary income rate.  If you withdraw funds prior to age 59½, it is subject to ordinary income tax plus a 10% additional tax penalty.  Contributions are maxed at the IRS limit of $18,000 or $24,000 if you are over the age of 50.  401(k) plans are offered by for-profit companies and the 403(b) plans are offered by nonprofit companies, religious groups, school districts, and governmental organizations.  If you leave your job that offers a 401(k) or a 403(b) plan for a new company, you can leave your plan with your old employer or you can roll over the plan to the new employer’s 401(k), 403(b), or your own IRA. 
  • IRA – This is an Individual Retirement Account that anyone can contribute up to the IRS limit of $5,500 or $6,500 if they are over the age of 50. Withdraws prior to age 59½ are subject to be included in gross income plus a 10% additional tax penalty.  Funds grow tax-free and you can contribute to both an IRA and 401(k), but if you are covered by an employer plan, your IRA contributions are not tax deductible if you earn more than $72,000 annually for single filers or $119,000 for married filing jointly
  • Roth IRA – Contributions are with after-tax dollars and there is no tax deduction on your contributions. The funds do grow tax-free and no tax is applied on withdrawals after age 59½.  Distributing funds before age 59½, will incur a 10% tax penalty assessed on the earnings withdrawn.  There are no required minimum distributions (RMDs) after age 70½, unlike the traditional IRA, 401(k), and 403(b) accounts above.  To qualify for a Roth IRA, adjusted gross income (AGI) must be less than $133,000 for single filers or $196,000 for married filing jointly.  You may contribute to a Roth IRA and a traditional IRA, but your total contribution to both cannot exceed the $5,550 or $6,500 for ages over 50, as stated above.  Young workers benefit from contributing to a Roth IRA because it is assumed they will be in a lower tax bracket when contributing funds compared to when they are distributing funds after age 59½.
  • Brokerage Account – Funded with after-tax dollars and not tax-deferred. You pay taxes on any dividends earned each year, and on any gains you may incur from a sale.  Depending on how long you held the securities, capital gains can be classified as short-term or long-term, with taxes ranging from 0-20% There are no contribution limits or a tax penalties if funds are withdrawn before a certain age.  This offers greater flexibility and availability compared to the tax deferred or tax-free accounts above.

These accounts are great in their own way, but utilizing a blend of accounts can help create a tax-efficient strategy towards saving for retirement. 

How Much Do I need to Know About Investing?

While investing can sometimes be complicated, there are a couple of basic principles that can help guide you.

  • Diversify your retirement savings! This is a risk management technique that ensures you are invested in a broad range of investments, such as, foreign and domestic stocks and bonds. Although it is does not guarantee against losses, it is one of the most important components in reaching retirement goals while minimizing risk.
  • Understand your risk tolerance. Saving for retirement is a marathon, not a sprint!  Try to take emotions out of your strategy to ensure you don’t make a snap decision based on short term volatility.  Depending on where you are on your retirement timeline, these times of volatility can provide potential buying opportunities, keeping true the adage “Buy low and sell high”.

If you are still in need of some help or guidance, contact your investment advisor or financial planner to help provide the best possible retirement strategies.  At Hoover Financial Advisors, we are always willing to help implement strategies and help guide you in these important decisions. 

Sources

Vanguard -Retirement Savings

Business Insider – Here’s the Difference Between Someone Who Starts Saving at 25 vs Someone Who Starts at 35

Investopedia – Top 4 Reasons To Save For Retirement Now

US News – 7 Retirement Savings Accounts You Should Consider

CNN Money – Ultimate Guide to Retirement

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