What Is Retirement Planning?

Retirement planning involves determining retirement income goals and what's needed to achieve those goals. Retirement planning includes identifying income sources, sizing up expenses, implementing a savings program, and managing assets and risk. Future cash flows are estimated to gauge whether the retirement income goal is possible.

You can start at any time, but it works best if you factor it into your financial planning as early as possible. That’s the best way to ensure a safe, secure—and fun—retirement. The fun part is why it makes sense to pay attention to the serious and perhaps boring part: planning how you’ll get there.

How Retirement Planning Works

In the simplest sense, retirement planning is what one does to be prepared for life after paid work ends. This isn't just financially but in all aspects of life. The non-financial aspects include lifestyle choices such as how to spend time in retirement, where to live, and when to quit working altogether, among other things. A holistic approach to retirement planning considers all these areas. The emphasis that one puts on retirement planning changes at different stages of life. For instance:

• Early in a person’s working life, retirement planning is about setting aside enough money for retirement.
• During the middle of your career, it might also include setting specific income or asset targets and taking steps to achieve them.
• Once you reach retirement age, you go from accumulating assets to what planners call the distribution phase. You’re no longer paying into your retirement account(s). Instead, your decades of savings begin paying you out.

How Much Do You Need to Retire?

Remember that retirement planning starts long before you retire. The general rule is the sooner you start, the better. Your magic number, which is the amount you need to retire comfortably, is highly personalized. But there are numerous rules of thumb that can give you an idea of how much to save.

How much you need depends on who you ask. For instance:

• People used to say that you need around $1 million to retire comfortably.
• Other professionals use the 80% rule, which states that you need enough to live on 80% of your income at retirement. So if you made $100,000 per year, then you would need savings that could produce $80,000 per year for roughly 20 years, or a total of $1.6 million, including the income generated by your retirement assets.
• Others say most retirees aren’t saving anywhere near enough to meet those benchmarks and should adjust their lifestyle to live on what they have.
  

While the amount of money you'll want to have in your nest egg is important, it's also a good idea to consider all of your expenses. Be sure to calculate the costs for housing, health insurance, food, clothing, and your vehicle/transportation. And since you'll have more free time on your hands, you may also want to factor in the cost of entertainment and travel. While it may be hard to come up with concrete figures, be sure to come up with a reasonable estimate so there are no surprises later on.

Steps to Retirement Planning

Regardless of where you are in life, there are several key steps that apply to almost everyone during their retirement planning. The following are some of the most common:

1. Come up with a plan. This includes deciding when you want to start saving when you want to retire, and how much you'd like to save for your ultimate goal.
2. Decide how much you'll set aside each month. Using automatic deductions takes away the guesswork, keeps you on track, and takes away the temptation to stop or forget depositing money on your own.
3. Choose the right accounts for you. Take the chance to invest in a 401(k) or similar account if your employer offers that option. Remember, if the company offers an employer match and you don't sign up, you're just giving away free money. And don't forget to have an emergency fund, which can be easily liquidated if you need cash in a pinch.
4. Check on your investments from time to time and make periodic adjustments. It's always a good idea to make any changes whenever there's a change in your lifestyle and when you enter a different stage in your life.
   

Retirement Plans

Retirement accounts come in many shapes and sizes. The rules and regulations for each may be different.

Employer-Sponspored Plans

Young adults should take advantage of employer-sponsored 401(k) or 403(b) plans. The former is a type of retirement account offered by major corporations. The latter is a similar plan used by employees of public schools and certain charities. Both work in similar fashions.

An up-front benefit of these qualified retirement plans is that your employer has the option to match what you invest up to a certain amount. For example, if you contribute 3% of your annual income to your plan account, your employer may match that and deposit the equivalent sum into your retirement account, essentially giving you a 3% bonus that grows over the years.

You can and should contribute more than the amount that will earn the employer match. In fact, some experts recommend upward of 10%. Participants under age 50 can contribute up to $22,500 of their earnings in 2023 and $23,000 in 2024 to a 401(k) or 403(b), some of which may be additionally matched by an employer. People over age 50 can contribute an extra $7,500 per year as a catch-up contribution in both 2023 and 2024.

Additional advantages of 401(k) plans include earning a higher rate of return than a savings account (although the investments are not free of risk). The funds within the account are not subject to income tax until you withdraw them. Since your contributions are taken off your gross income, you will get an immediate income tax break. Those who are on the cusp of a higher tax bracket might consider contributing enough to lower their tax liability.

Traditional Individual Retirement Accounts (IRAs)

The traditional individual retirement account (IRA) lets you put aside pre-tax dollars. This means that the money you save is deducted from your income before your taxes are taken out. As such, it lowers your taxable income and, therefore, your tax liability. So if you're on the cusp of a higher tax bracket, investing in a traditional IRA can knock you down to a lower one.

The tax benefit to this kind of account is upfront. So when it comes time to take distributions from the account, you are subject to your standard tax rate at that time. Keep in mind, though, that the money grows on a tax-deferred basis. There are no capital gains or dividend taxes that are assessed on the balance of your account until you begin making withdrawals.

The IRS sets limits on how much you can contribute to a traditional IRA each year. This figure is set based on inflation. The limit for 2023 is $6,500 ($7,000 in 2024). People who are 50 and older can invest an additional $1,000 for a total of $7,500 in 2023 ($8,000 in 2024).

Distributions must be taken at age 72 and can be taken as early as 59½. You are subject to a 10% penalty if you make withdrawals before that. You will also incur taxes at your regular income tax rate.

Roth Individual Retirement Account (IRA)

A Roth IRA can be an excellent tool for young adults, funded with post-tax dollars. This eliminates the immediate tax deduction but avoids a more significant income tax bite when the money is withdrawn at retirement. Starting a Roth IRA early can pay off big time in the long run, even if you don’t have a lot of money to invest at first. Remember, the longer the money sits in a retirement account, the more tax-free interest is earned.

Roth IRAs have some limitations. The contribution limit for either IRA (Roth or traditional) is $6,500 a year, or $7,500 if you are over age 50 ($7,000 and $8,000, respectively, for 2024). Still, a Roth has some income limits. For instance:

• A single filer can contribute the full amount only if they make $138,000 or less annually, as of the 2023 tax year, and $146,000 in 2024.
• After that, you can invest to a lesser degree, up to an annual income of $153,000 in 2023 and $161,000 in 2024.

Note that the income limits are higher for married couples filing jointly.

Like a 401(k), a Roth IRA has some penalties associated with taking money out before you hit retirement age. But there are a few notable exceptions that may be very useful for younger people or in case of emergency. First, you can always withdraw the initial capital you invested without paying a penalty. Second, you can withdraw funds for certain educational expenses, a first-time home purchase, health care expenses, and disability costs.

SIMPLE Individual Retirement Account (IRA)

The SIMPLE IRA is a retirement account offered to employees of small businesses instead of the 401(k), which is expensive to maintain. It works the same way a 401(k) does, allowing employees to save money automatically through payroll deductions with the option of an employer match.

This amount is capped at 3% of an employee's annual salary. The annual contribution limit for a SIMPLE IRA is $15,500 in 2023 and $16,000 in 2024. Catch-up contributions of $3,500 allow employees 50 or older to bump that limit up to $19,000 in 2023 and $19,500 in 2024.

Stages of Retirement Planning

Below are some guidelines for successful retirement planning at different stages of your life.

Young Adulthood (Ages 21–35)

Those embarking on adult life may not have a lot of money free to invest, but they do have time to let investments mature, which is a critical and valuable piece of retirement savings. This is because of the principle of compounding.

Compound interest allows interest to earn interest, and the more time you have, the more interest you will earn. Even if you can only put aside $50 a month, it will be worth three times more if you invest it at age 25 than if you wait to start investing until age 45, thanks to the joys of compounding. You might be able to invest more money in the future, but you’ll never be able to make up for any lost time.

Early Midlife (Ages 36–50)

Early midlife tends to bring a number of financial strains, including mortgages, student loans, insurance premiums, and credit card debt. However, it’s critical to continue saving at this stage of retirement planning. The combination of earning more money and the time you still have to invest and earn interest makes these years some of the best for aggressive savings.

People at this stage of retirement planning should continue to take advantage of any 401(k) matching programs that their employers offer. They should also try to max out contributions to a 401(k) or Roth IRA (you can have both at the same time). For those ineligible for a Roth IRA, consider a traditional IRA. As with your 401(k), this is funded with pretax dollars, and the assets within it grow tax-deferred.

Some employer-sponsored plans offer a Roth option to set aside after-tax retirement contributions. You are limited to the same annual limit, but there are no income limitations as with a Roth IRA.

Finally, don’t neglect life insurance and disability insurance. You want to ensure that your family could survive financially without pulling from retirement savings should something happen to you.

Later Midlife (Ages 50–65)

As you age, your investment accounts should become more conservative. Treasury bills (T-bills) are one of the most conservative investments, but their returns are also low compared to other investments.

While time is running out to save for people at this stage of retirement planning, there are a few advantages. Higher wages and potentially having some of the aforementioned expenses (mortgages, student loans, credit card debt, etc.) paid off by this time can leave you with more disposable income to invest.

And it's never too late to set up and contribute to a 401(k) or an IRA. One benefit of this retirement planning stage is catch-up contributions. From age 50 on, you can contribute an additional $1,000 a year to your traditional or Roth IRA and an additional $7,500 a year to your 401(k) in 2023 and 2024.

For those who have maxed out tax-incentivized retirement savings options, consider other forms of investment to supplement your retirement savings. Certificates of deposit (CDs), blue-chip stocks, or certain real estate investments (like a vacation home that you rent out) may be reasonably safe ways to add to your nest egg.

You can also begin to get a sense of what your Social Security benefits will be and at what age it makes sense to start taking them. Eligibility for early benefits starts at age 62, but the retirement age for full benefits is 66.

This is also the time to look into long-term care insurance, which will help cover the costs of a nursing home or home care should you need it in your advanced years. If you don't properly plan for health-related expenses, especially unexpected ones, they can decimate your savings.

Other Aspects of Retirement Planning

Retirement planning includes a lot more than simply how much you will save and how much you need. It takes into account your complete financial picture.

Your Home

For most Americans, the single biggest asset they own is their home. How does that fit into your retirement plan? A home was considered an asset in the past, but since the housing market crash, planners see it as less of an asset than they once did. With the popularity of home equity loans and home equity lines of credit (HELOCs), many homeowners are entering retirement in mortgage debt instead of well above water.

Once you retire, there’s also the question of whether you should sell your home. If you still live in the home where you raised multiple children, it might be more significant than you need, and the expenses that come with holding onto it might be considerable. Your retirement plan should include an unbiased look at your home and what to do with it.

Estate Planning

Your estate plan addresses what happens to your assets after you die. It should include a will that lays out your plans, but even before that, you should set up a trust or use some other strategy to keep as much of it as possible shielded from estate taxes. 

As of 2024, the first $13.61 million of an estate is exempt from estate taxes (up from $12.92 million for 2023), but more and more people are finding ways to leave their money to their children in a way that doesn’t pay them in a lump sum. There may also be changes coming down the pipeline in Congress regarding estate taxes, as the estate tax amount is scheduled to drop to $5 million in 2026.

Tax Efficiency

Once you reach retirement age and begin taking distributions, taxes become a big problem. Most of your retirement accounts are taxed as ordinary income tax. That means you could pay as much as 37% in taxes on any money that you take from your traditional 401(k) or IRA. That’s why it’s essential to consider a Roth IRA or a Roth 401(k), as both allow you to pay taxes upfront rather than upon withdrawal.

If you believe you will make more money later in life, it may make sense to do a Roth conversion. An accountant or financial planner can help you work through such tax considerations.

Insurance

A key component of retirement planning is protecting your assets. Age comes with increased medical expenses, and you will have to navigate the often-complicated Medicare system. Many people feel that standard Medicare doesn’t provide adequate coverage, so they look to a Medicare Advantage or Medigap policy to supplement it. There’s also life insurance and long-term care insurance to consider.

Another type of policy issued by an insurance company is an annuity. An annuity is much like a pension. You put money on deposit with an insurance company that later pays you a set monthly amount. There are many different options with annuities and many considerations when deciding if an annuity is right for you.

The Bottom Line

Everyone dreams of the day they can finally say goodbye to the workforce and retire. But doing so costs money. That's where retirement planning comes into play. And it doesn't matter at which point you are in your life. Sure, you may have Social Security benefits, but that may not be enough, especially if you're used to a certain lifestyle. Setting aside money now means you'll have less to worry about later.