Saving for retirement can be intimidating. There are many options to choose from that can make the process seem difficult or confusing. However, that does not have to be the case so long as you learn what works for you. Once personalized, retirement can be a stress-free journey.
One of the most important aspects of retirement planning is understanding your goals and the different resources that cater to them.
WHEN CAN YOU REALLY RETIRE?
Good decisions made at the start of this journey can be instrumental in helping investors reach their retirement goals. The general advice is to start sooner rather than later. Having a broad idea of when you see yourself retiring is enough to help you set reasonable goals. Small contributions can have a compounding effect on the future. Goals are always changing, and retirement goals are no exception.
Many investors consider the earliest retirement age to be 59.5 years. At this milestone, workers who have been contributing to retirement accounts are able to start withdrawing. According to Gallup, the actual average retirement age is 62 years old and increasing.
It is important to determine how much you need to save to live the retirement you want. Everyone has different standards and expectations for retirement when it comes to travel, house remodeling, and other lifestyle choices. Anyone planning to enjoy a luxurious retirement should start investing sooner and make the most of their contributions. Those seeking a simpler retirement may be okay spending more money and taking more time off during their working years.
WHAT IS YOUR RISK LEVEL?
When most people think of risks in investing, they think of the money they could lose. However, you also need to consider the loss of opportunity and growth.
There are two traditional methods of investing:
Slow and Steady: Classic story of playing on the safe route with a modest return. A reliable method of investment without the upward and downward swings of the world economy. Slow and steady investing includes government bonds, exchange-traded funds, and stocks that may appear undervalued.
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Growth: This method will primarily have investors holding individual stocks or high-yield mutual funds. The goal here is to have great gains in shorter time spans. For investors with a tolerance of the volatility or perhaps some hefty “play money,” growth investing can be exciting and very rewarding.
It should be no surprise that these vastly different methods of investing appeal to different investors who have unique needs and risk tolerances. Younger investors have a longer time horizon and may opt for riskier investments because they have time to recover from losses. Alternatively, young investors who are more risk-averse may choose the slow and steady route by making less risky investments. Since they have more time until retirement, cost-efficient contributions with lots of time for compounding interest can pay off.
Those who don’t invest until later in life or missed opportunities when they were younger are out of the waiting game young investors are in. This means older investors may want to focus on maximum contributions and take on more risk since their compounding time is significantly lower. This can be a tricky time for investing though because any losses sustained when you’re closing in on retirement can reduce your nest egg and affect the quality of your retirement.
WHICH RETIREMENT ACCOUNT IS RIGHT FOR YOU?
There can be an almost overwhelming number of different options for investors to choose from and seemingly never enough clarity. Here, I will break down some of the most common retirement planning tools into more digestible pieces and explain whom they can best serve.
Traditional IRA: An Individual Retirement Account (IRA) grows on pre-tax contributions. Interest accrued is tax-deferred. The downside to this account is that withdrawals are taxed at the retiree’s income tax rate. In other words, if you retire in a higher tax bracket, you will pay more tax on those dollars. Traditional accounts offer a greater immediate rate of growth than a Roth IRA because the investor isn’t paying taxes immediately and therefore has more to invest. This also allows them to lower their adjusted gross income, which, in addition to reducing your taxes, can also have a favorable effect on your Social Security benefits and more.
Traditional 401(k): The Traditional 401(k) is another pre-tax growth opportunity, which is offered only through employers. The contributions into this account are taken from an investor’s gross income before it has been taxed. A fantastic benefit of most 401(k)s is employer matching. Employers can offer matching contributions on a percentage of the employee’s contribution based on the employee’s years of service. Traditional 401(k) accounts will often offer fewer options and less diversity of investments than an IRA.
Roth IRA: Investors who are starting later in life may see better results if they choose a Roth account, which is not tax-deferred. This account type works similar to the Traditional IRA, but with one large difference: contributions into a Roth IRA are post-tax. This means that the funds deposited into the account are not subject to income tax when they are withdrawn. After the account has been held for five years, or the investor ages 59.5 years, withdrawals will be tax-free. One of the drawbacks of this account type is the income cap and varying authorized contribution amounts. For 2021, the income limit for a single-person household that contributed to their Roth IRA was $140,000.
Roth 401(k): This account is similar to the Roth IRA but there are some noteworthy differences. The Roth 401(k) has greater contribution limits than the IRA and allows employer matching. However, the employer match is contributed pre-tax, meaning it will go into a traditional 401(k). Limits are based on age and are subject to change each year. For 2021, contribution limits were capped at $19,500, but investors over the age of 50 were granted an additional $6,500 in what is called a “catch-up” contribution. The Roth 401(k) does have the unique feature of allowing investors to take out loans of up to 50% of the account’s value. Lastly, unlike the Roth IRA, there is no income limit.
Annuity: This product is designed to work alongside Social Security or any other investments a person may have. The concept behind annuities is that they will provide for investors as a form of income after retirement. Investors make an initial investment, or premium payment, which grows tax-deferred. This means the earnings accrued will not be subject to taxation until the investor withdraws funds. Growth of the annuity occurs during the accumulation phase, which lasts anywhere from ten to thirty years. The distribution phase is when the annuity is paid out to the investor. There are different types of annuities that appeal to various goals of investors. Fixed, variable, and fixed indexed are the three most popular. Fixed annuities provide the greatest security by locking the interest rate. Variable annuities carry higher risk because their rate is not locked and may fluctuate in or out of the investor’s favor. Fixed indexed annuities are unique, as they will not drop below a set rate. However, because of their safety net feature, indexed annuities will typically have a higher premium and maintenance cost.
Social Security: Probably the most well-known of the retirement tools is Social Security. This is a universally available form of post-retirement income. Social Security acts as an insurance program where workers pay a portion of their income into a Social Security Trust Fund. These funds are available to anyone over 62 years old who has made contributions for at least 10 years. Workers who retire later can receive larger payouts for their extended payments to the Trust. However, Social Security has fallen under speculation in recent years with the retirement of the Baby Boomer generation and the average life expectancy of future retired generations. For these reasons, current investors should look at Social Security as a secondary source of income.
THE BOTTOM LINE
Retirement is a journey with many milestones. Results will vary from investor to investor. The individual’s timeline for investing and saving can have a great effect on the outcome, but that should never deter anyone from investing later in life.
Consulting a financial advisor or management group is highly recommended. These parties can help provide guidance or clarity in a field that seems crowded with options. Making the process of retirement planning more comfortable and understandable is important. Investors should explore options and assess their tolerance for risk when deciding the various methods of saving and investing.
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