4 Step Guide to Retirement Planning

Step 1: Figure Out How Much You’ll Need to Retire

Retirement is a unique proposition for each person, and for every couple. As such, determining the amount you need to retire comfortably is not only a financial calculation — but also a personal one.

The first step, even before you think about numbers, is to map out the key factors in your quality of life in retirement. You might want to ask yourself (and your spouse or partner) what your expectations are, such as:

•   Do you imagine working part-time in retirement, for fun or for income, or both?

•   Do you intend to pursue specific projects, hobbies, or goals?

•   What’s your interest in traveling vs. staying close to home?

•   Do you envision downsizing, moving near family, or perhaps even moving abroad?

There are no right answers. And your answers may change over time, as you revisit the retirement conversation. You may even want to retire early. But it’s important to start with your current retirement vision so that you can begin to anticipate and save for likely expenses.

Recommended: Take our Retirement Quiz to see how prepared you are for retirement.

Common Retirement Expenses to Consider

You can begin calculating what you’re likely to spend in retirement based on what you spend now.

Gather any information you generate from your list, to shed light on potential retirement expenditures. You can use the following list to think through which expenses may increase in retirement, which may decrease, and which might go away. (For example, once you’re retired you may not need a line item for retirement savings.)

Step 2: Start Saving Now

The more time you have, the more the money you invest has time to grow. The value of compound returns can’t be underestimated. Compounding means that as your investments gain value, the returns also grow.

There are no guarantees that your portfolio will always be on an upswing, however. But that’s another reason to put time on your side and start investing sooner rather than later. With enough time, your portfolio can weather the market’s natural ups and downs and, ideally, have time to recover.

So even if you think you’re late to the game, getting started ASAP is still the smartest strategy. That way when the questions get more serious and you start to wonder, When can I retire?, you’ll be in good shape.

Saving in the Midst of Competing Priorities

Saving enough for retirement can be challenging. Everyone is dealing with competing wants and needs. There’s a natural tendency to focus on your immediate goals and deprioritize the future — thinking you’ll catch up at some point.

In fact, it’s important to assess your current expenses and ask yourself whether you can reduce your cost of living now in order to save more for life in retirement.

After all, let’s say your retirement portfolio earns a solid 10% over time (the average return of the stock market is about that, but individual portfolios often earn in the 5 to 7% range). That still means a significant amount of your nest egg comes from what you save. To ensure you’re salting away as much as you comfortably can, take these steps:

•   Double check your current rate of retirement savings. If you’re enrolled in a 401(k), you probably allotted a certain percentage of your salary. Could you increase that amount by even 1%?

•   If you have an IRA that you’re funding, be sure to set up a regular cadence for your contributions so you can take advantage of dollar cost averaging.

•   To save more, make all your contributions automatic.

Step 3: Choosing a Retirement Plan

Understanding your different retirement plan options is an important way to leverage your savings, make smart decisions about taxes, and hopefully come out ahead.

Workplace Retirement Plans

There are many advantages to contributing to a 401(k) plan (if you work at a for-profit company) or a 403(b) plan (if you work at a nonprofit), or a 457(b) plan (if you work for the government).

These plans are tax deferred, meaning: Your employer can deduct your contributions from your paycheck, so you don’t pay tax on the money now — in fact, these contributions effectively lower your taxable income. So you may owe less in taxes now. But you will owe tax when you take withdrawals in retirement.

Many employers deduct your contributions automatically, which can help you save more, effortlessly. And in some cases your employer may offer a matching contribution: e.g. up to 3% of the amount you save.

Contribution limits for workplace plans for tax year 2024 are $23,000, and $30,500 if you’re 50 and older. Check with your employer about any other factors, investment options, and matching funds.

Individual Retirement Accounts (IRAs)

Another retirement savings option, especially if you’re one of the many freelancers or contract workers in the American workforce, is to open an individual retirement account (IRA).

Like a 401(k), an IRA allows you to put away money for your retirement. However, for tax year 2024 the maximum contribution you can put into your IRA is capped at $7,000 ($8,000 for those 50 and older). The lower savings amount is somewhat made up for by the fact that an IRA usually has a much wider array of investment options.

Both the traditional IRA and 401(k) offer tax-deductible contributions; again, with tax-deferred accounts, you typically pay tax when you take withdrawals in retirement.

Roth IRAs are another option: With a Roth IRA, your contributions are made with after tax dollars. Thus, since you’ve already paid tax on those deposits your withdrawals in retirement will be tax free.

Roth accounts are subject to income limits, however, so it’s best to check with the IRS or a financial professional before opening a Roth IRA.

For those who can afford to invest money in both an IRA and a 401(k), and who meet the criteria, that’s another way to boost retirement savings. However, bear in mind that the IRS imposes restrictions on combining certain accounts, so it’s important to know the rules.

Step 4: Managing Your Portfolio

Learning a few of the fundamentals of portfolio management is another key to staying on the path to your goals.

Asset Allocation

Asset allocation refers to the practice of investing across asset classes in order to balance potential risks and rewards. The three main asset classes are stocks, bonds, and cash.

In addition to stocks, bonds, and cash, some investors also allocate money into real estate, commodities, or even alternative investments. Determining what kind of asset allocation makes the most sense for you depends on personal goals, time horizon, and risk tolerance.

Some people use the formula of 100 – [your age] to arrive at your base equity allocation. If you’re 35, 100 – 35 = 65; thus, you could consider putting 65% of your portfolio in equities (stocks), and the remainder into bonds and cash. This is just one formula; people use different ways of determining their asset allocation — especially their tolerance for risk.

Diversification

Asset allocation is related to portfolio diversification. Diversification means spreading one’s money across a range of assets. It’s like the age-old advice to not put all your eggs in one basket. An investor can’t avoid risk entirely, but diversification can help mitigate some investment risks.

Bonds, for instance, can balance stocks as they generally have a lower risk profile. Real estate can be a hedge against inflation, and has low correlation with stocks and bonds, which can provide protection against market downturns. Investors can explore how portfolio diversification might benefit them.

Investment Funds

When setting up your portfolio within your IRA or 401(k), or other retirement account, you may want to consider different types of investment funds.

•   Mutual funds are a type of pooled investment that may hold dozens or hundreds of securities; investors can buy and sell mutual fund shares rather than owning each type of security themselves. Mutual fund shares can be traded once a day.

•   Exchange-traded funds (ETFs) are similar to mutual funds in that they are also a type of pooled investment fund, but shares of ETFs can be traded throughout the day, like stocks.

•   Target date funds are similar to mutual funds in that you can buy shares of these funds. But they are designed as more or less complete retirement portfolios, in that they include a mix of asset classes based on your chosen retirement year.

Additional Considerations for Your Retirement

It’s important to think about your retirement lifestyle, as well as different types of retirement accounts, the need to understand various asset classes, and how diversification works.

In addition, when planning ahead for a well-rounded retirement it’s also essential to put some thought into other key aspects of retirement.

Understanding Social Security

All U.S. workers pay a tax that goes into the Social Security system. When you retire, you are entitled to claim your Social Security benefits starting as early as age 62, but the amount you get will be higher or lower depending on how old you are when you apply.

For every year you wait after age 62, which is considered an early retirement, you get more money. If you wait until age 70 you will get the maximum amount.

Social Security is complicated, especially if you’re divorced, disabled, or your spouse is deceased. Be sure to check with SSA.gov to understand the rules for claiming Social Security.

Healthcare Coverage

After you retire, having the right healthcare insurance becomes increasingly important. You may want long-term care insurance as well. Most retirees use some combination of Medicare and private insurance.

The type of coverage you’ll need depends on your health and well-being, and what you can afford. As you’re looking ahead, be sure to plan for this additional expense.

Downsizing and Debt Management

How much debt you have can have a big impact on your retirement because it can add to your expenses. If possible, you want to have as many of your debts paid off as you can before you retire. With retirement years away, you can plan to pay off:

•   Credit cards

•   Student loans

•   Vehicle loans

•   Personal loans

•   Medical debt

You may also want to pay off your mortgage before you retire, or move to a smaller home with a smaller mortgage. This is one reason why some retirees choose to downsize. But downsizing in today’s market is complicated, given the tight housing market.

As with most aspects of your retirement plan, what you decide and the strategies you use to get there will be based on your personal circumstances. It can be tough to find ways to pay off debt when you’re starting a family or a business (or both). When the time comes for you to retire, it may make more sense to downsize versus how things look today.