Several Key Retirement Planning Steps

Retirement income is an essential aspect of financial planning. Because calculating the precise length of retirement is impossible, retirees should build a financial cushion that ensures they can enjoy a comfortable, secure quality of life for as long as possible. Not only do they need to earn and save income, but they also need to invest their savings and grow them to fund their retirement.

Retirement planning involves five elements: time horizon, expenses, after-tax returns, risk tolerance, and estate planning. The earlier a person begins planning, the more their investment can grow and compound over time. A 25-year-old with 40 years until retirement can invest in riskier aspects such as stocks, which are subject to market volatility but perform better in the long term. Additionally, younger workers should consider higher-risk options to ensure their returns outpace inflation.

Individuals closer to retirement should focus on preserving capital. Less risky options such as bonds will bring lower returns than stocks and provide stable income. Bonds also make inflation less of a concern.

Next, retirement planning involves a thorough calculation of retirement costs and spending needs. On average, people estimate their annual spending in retirement will amount to just 70 to 80 percent of their spending.

However, this may be realistic, particularly if an individual incurs unexpected medical expenses or still has a mortgage payment. Many financial advisors recommend that retirees plan on maintaining 100 percent of their previous spending habits.

Further, because retirees have more time to travel and engage in hobbies, many find their retirement spending outpaces their previous spending. An accurate picture of their lifestyle and withdrawal rate will help retirees save and invest responsibly. Additionally, retirees should remember that average life spans are increasing, and they may wish to one day purchase another home or fund a child or grandchild’s education.

Taxes also play an important role in retirement planning. If money contributed to retirement accounts has given individuals tax deductions, withdrawing those funds later will bring a large tax bill. Any required rate of return over 10 percent is unrealistic, and the return threshold goes down as retirees age.

The earlier one plans for retirement, the more protected they are against an unrealistic rate of return. For example, with a $1 million gross retirement investment account, the same living costs would decrease the return to a more reasonable five percent.

Retirees should choose financial products in line with their risk tolerance and financial objectives. To fund required expenditures, they could place some income in risk-free Treasury bonds. They should also remember that the market fluctuates, but they should not panic and sell during declines.

Finally, a good retirement plan includes estate planning and life insurance. Life insurance prevents loved ones from incurring financial burdens, while estate planning covers the distribution of assets after death. Both will help family members avoid a lengthy and costly probate process, which involves the court validating a will.

Overall, effective retirement planning balances risk and return and regular monitoring to respond to changing market conditions.