1) Plan For Your Retirement
Sorry for having to state the obvious. You’re not going to get to retire if you don’t plan. This is the price of admission. After all, it is your retirement we are talking about here. This plan can be as simple or elaborate as you like. I prefer simple. When things are simple, they are easier to understand. When things are easier to understand they generally are easier to implement. And that’s what we are talking about here. Making sure you implement your retirement plan. Not talking about your plan to retire. Designing and then implementing your retirement plan.
Any plan that is going to be implemented needs to be put in writing. You can’t have your retirement plan in your head. It just isn’t going to work. This plan would include when you planned to retire and what resources you will have to get you there. Again, keep it simple. A couple of bullet points about what your financial goals and objectives are. Then prepare a statement of net-worth that shows your assets, liabilities and net-worth. Additionally you’ll need a statement of your expected income and expenses for the year. Some used to call this a budget. That sounds too restrictive to us. We prefer the term spending plan. What are you planning on spending your money on?
After you have your plan you will need to check in with it periodically. This doesn’t mean every day. Perhaps twice a year you should review where you are and compare this to your goal.
All investors will need to manage their income taxes. That’s why it’s important to know How to Use the Tax Code to Retire in Style.
2) Save For Your Retirement
This is where the rubber meets the road. Nothing else matters if you aren’t going to save. No savings, no retirement. Period. End of story. Get the picture? Your father or grandfather likely had a pension to retire on along with their Social Security Benefits. Unless you work for the Federal, State, County or Municipal government you likely won’t be getting a pension. Without a pension what will you have? Your Social Security Benefit and whatever you can save. That’s it. Have you taken a look at Social Security lately? Like other facets of government, they are underfunded. This is a huge issue that will continue to get worse unless steps are taken. This might include extending the full retirement date or perhaps putting a cap on the amount of benefits someone can collect. Keep an eye on this.
The first thing to fund is your cash reserve fund. Most commentators suggest having at least six months in a cash reserve fund. I doubt many folks have anywhere near this amount. Shoot for three months and then try to add from there. Remember, your cash reserve fund needs to be tucked away into a money market account or savings account. These funds cannot be put at risk. You will need these funds someday. You don’t know when you will need them, but you will need them. Perhaps when your car breaks down or you get sick.
The best way to save is to put your savings on automatic pilot. Many employees will work for an employer that offers a 401(k) plan. Sign up for this plan your first day of work. Contribute an amount at least to get the employer match. If your employer does not offer a match you may have some legwork to do. You will need to carefully review the menu options in the plan. Also, take a hard look at the fees associated with the plan. If the menu of investment options is good and the fees are reasonable you will still want to contribute to the 401(k) plan even if there is no match.
The maximum amount that can be contributed to a 401(k) plan annually is $18,000. Taxpayers age 50 and older can contribute another $6,000 in a so-called catch-up contribution for a total of $24,000 per year. For many employees their 401(k) plan will be one of the cornerstones of their retirement plan.
3) Invest For Your Retirement
Now that you have been saving it’s time to invest. You will want to design an investment plan that will help you get to retirement when you want to. The key here of course is when will you need the money? If you are in your 20’s or 30’s you will have a very long timeline. You could be investing for another 20-30 years. Invest accordingly. Investors in their late 50’s or early 60’s will likely have a much shorter timeline.
You will also need to invest outside of your 401(k) plan. Younger employees that work for a company that offer a 401(k) plan should inquire if the company also offers a Roth 401(k) plan. The difference with the Roth 401(k) plan is that the contributions are put in with after tax dollars. With the 401(k) plan they are put in with pre-tax dollars. Younger employees just starting out in their career likely are not high income earners and therefore likely don’t have a very high tax bracket. The Roth 401(k) plan is generally a better alternative for them as the tax savings is not significant. Keep in mind if you do contribute to the Roth 401(k) and the employer matches, it will match with the traditional 401(k) match. In other words, when the employer matching funds are eventually distributed they will be taxed as ordinary income. Your contributions to the Roth 401(k) plan will however, assuming you meet the basic conditions mentioned below, will be income tax-free when distributed.
For many investors the Roth IRA is the ideal retirement vehicle. If you have earned income of at least $5,500 you can contribute up to $5,500 per year to a Roth IRA. Earned income is from working as an employee or perhaps being self-employed. Taxpayers over age 50 can contribute an additional $1,000 in a so-called catch up to a total of $6,500. Higher income taxpayers are not allowed to contribute to a Roth IRA. For married couples filing a joint return they can’t contribute to a Roth IRA when their modified adjusted gross income exceeds $184,000.
Unlike an IRA, there is no income tax deduction with a Roth IRA. The benefit of the Roth IRA however is that all of the distributions are income tax free if you meet two straight forward criteria. If you don’t take a distribution until after age 59 1/2 and the account has been open for at least five years then all of the distributions are tax-free. This is huge. When you retire any distributions from your 401(k) plan or IRA’s will be taxable. Additionally, up to 85% of your social security benefits could be taxable. Having a Roth IRA allows you to access tax-free funds if you need to. The other nice feature of the Roth IRA is that it is not subject to the Required Minimum Distribution (“RMD”) rules that 401(k) plans and IRA’s are. These RMD rules mandate that taxpayers begin taking distributions when they turn age 70 1/2. The IRS has a chart that essentially forces taxpayers to take these funds out over their life expectancy. Roth IRA’s are not subject to these RMD rules during the account owners and
surviving spouses lifetime. Non spouse beneficiaries like children and grandchildren that inherit a Roth IRA would be subject to the RMD rules.
4) Insure Your Retirement
You will need to plan, save and invest. These are three very important building blocks if you want to retire. With that said, it’s still not enough. You’re going to need to assess some of the risks you may face along the way.
If you have a mortgage on your home the lender will required you to maintain a homeowner’s insurance policy on the property. Heck, even if you don’t have a mortgage you sure would want to have a homeowner’s insurance policy. Homes can be a big investment. Connecticut drivers are mandated to have auto insurance. It fascinating that there is estimated to be 8% of drivers in Connecticut that don’t have auto insurance. But that’s another story.
Most folks should have a personal umbrella policy. This severs as a backstop to your homeowners and auto policies. This policy kicks in where the homeowners and auto insurance policies leave off. Everyone should have a minimum of $1 million of an umbrella policy.
So, after you have paid the homeowners, auto and umbrella insurance premiums I suspect you are done hearing about even more insurance. Not too many people want to talk about more insurance much less buy any. However there is insurance that almost everyone will need. If you have dependents you will (likely) need some life insurance. Dependents could be a spouse or minor children. The death benefit is designed to help them stay in a lifestyle they are accustomed to.
Another insurance most folks should look at is disability insurance. This insurance will pay you if you are unable to work for an extended period of time. Check with your employer to see if they offer any disability insurance for their employees.
Without having adequate life insurance a premature death may leave your survivors in a much more tenuous financial positon. If you become disabled and don’t have disability insurance, that nice retirement plan you designed goes down the drain.
5) Adjust and Adapt to Get To Your Retirement
Sometimes things don’t go as planned. That’s OK. Get used to it. The only thing we can count on is change. True that. That’s why everyone needs a Plan B.
You might get married and have children. Then you might be looking at saving for college in addition to saving for retirement. Ugh. That’s a lot of saving. Unless you have unlimited funds, you are going to need to prioritize what you are saving for. Saving for retirement should be your priority here. It’s possible your children may not go to the traditional four year college. Maybe they go to the local community college for two years. This can save you a ton of money. Perhaps they want to go to a trade school. Some will want to join the armed forces.
You might find you need to save more. Perhaps after having your second child you will need more life insurance. Maybe you have done very well early in your career and you might even change your career. Several times. Some careers pay more, some pay less. Hopefully you find one where you are reasonably happy and able to make and save enough to retire someday!
The information contained in this article does not purport to be a complete description of the securities, markets, or developments referred to in this material, is not a complete summary or statement of all available data necessary for making an investment decision, and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Tom Scanlon and not necessarily those of RJFS or Raymond James.