5 essential steps to take when planning for retirement

While you can complete much of the work up front, retirement planning is a process that evolves over time as you adapt to changing circumstances, priorities and goals. As such, it’s important to occasionally revisit your plan to ensure you’re still on track.

5 essential steps to take when planning for retirement

The idea of planning for life after work can be intimidating. You want to save enough so you don’t run out of money, but you need to balance your need for adequate savings with today’s financial priorities.

Planning for retirement involves five essential steps that, if followed, will help you create a strategy to establish, grow and manage your retirement savings as a part of your overall financial picture.

1. Start saving and continue saving

According to Goldman Sachs’s 2022 Retirement Survey and Insights Report, more than 40% of American workers believe their savings are behind schedule. If you want to put yourself in the best position to retire with enough money saved, start saving and keep saving.

Compounding plays a critical role in long-term saving and investing because it makes your money grow faster. Compounding is the process of earning returns on your initial investment, ongoing contributions and any returns you received previously, whether from interest, dividends or appreciation of the investment itself. In other words, it’s the money you earn on your money. The longer you give compounding to build up steam, the more powerful it becomes, and the larger it grows your wealth.

For example, say you purchase a $1,000 bond that pays interest at an annual rate of 4% and you reinvest the interest each year. At the end of year one, you’ll have earned $40 in interest. Assuming you make no additional investments, your beginning balance in year two would be $1,040. Even though the interest rate remains stable at 4%, your balance at the end of the second year would be $1,081.60. You’ll have earned $41.60 in interest this time. The interest paid each year becomes larger and larger because of compounding, which emphasizes the importance of saving as early as possible.

2. Know your retirement spending needs

Retirement can be expensive. We’re living longer, medical care is getting more expensive and taxes aren’t going away. Since 2000, the cost of health care — including medical services provided, as well as health insurance, drugs and medical equipment — has risen 111%. Plus, you may want to travel and dine out more. You know, enjoy your retirement?

Experts say you’ll need at least 80% of your pre-retirement income when you leave your job. This accounts for the expenses you may no longer have when you retire — things like commuting costs and life insurance.

Where are retirees spending most of their money, then?

According to the Employee Benefit Research Institute’s (EBRI) 2022 Spending in Retirement Survey, retirees spent 30% of their monthly income on housing expenses, 25% on food and 13% on health insurance and out-of-pocket medical costs. While some expenses may disappear, there’s no guarantee you’ll spend less money in life after work. According to Goldman Sachs, nearly 25% of Americans spent more in retirement in 2022 than they had planned.

With expected expenses and your ideal retirement lifestyle in mind, you can implement some further savings guidelines to help you determine how much money you’ll need saved to fund your retirement. One such guideline is the 4% withdrawal rule.

The 4% withdrawal rule

First articulated by financial adviser William Bengen in 1994, the 4% withdrawal rule has been a popular guideline for determining how much money people need to save for a lasting retirement. The rule states that you should start retirement by withdrawing 4% of your savings annually, adjusting for inflation each year. According to Bengen, your portfolio should last at least 30 years by following this rule.

Bengen has since adjusted his rule to 4.7%. Morningstar puts the starting withdrawal rate closer to 3.8%.

3. Consider your time horizon

Your time horizon dictates how you need to be investing to reach your retirement savings goals. It tells you how long your money can work for you, and it should be front of mind when deciding on your risk tolerance and overall asset allocation.

Your time horizon also includes how long you’ll need your money to last once you stop working. With an average life expectancy in America of around 80 years old, if you want to retire at age 65, you’ll need enough money to last you at least 15 years.

It’s worth noting that your retirement savings may not be the only source of income you’ll have in retirement. If it survives, Social Security can help pad your income.

The earliest you can start taking Social Security benefits is age 62, but you won’t be entitled to your full benefit amount until you reach your full retirement age. If you were born in 1960 or later, your full retirement age is 67. But if you can delay retirement until age 70, you’ll get the most money.

4. Determine an investment strategy

Your time horizon and retirement spending needs can inform your investment strategy. If you’re younger, you can tolerate more risk because you have more time to make up for any potential losses. If you’re closer to retirement, you may choose to prioritize preserving your savings.

Stocks, though they can be volatile in the short term, offer significant potential for growth over the long haul. The average historical stock market return has been about 10% a year (around 7% after inflation). If you have many years before retirement, riskier assets such as stocks are more acceptable. On the other hand, stable investments like bonds are likely more suitable if you’ll need your money in a couple of years.

Lower-returning investments like bonds, though, face inflation risk. You don’t want inflation to outpace the return on your investments. A diversified portfolio can help mitigate risks like inflation.

5. Leverage tax-advantaged retirement accounts

Retirement accounts like the 401(k) and the individual retirement account (IRA) let you save for retirement in a tax-advantaged way. These accounts give you an added financial incentive to save money for retirement.

The traditional version of the 401(k) and IRA give you upfront tax benefits by lowering your taxable income in the year in which you make a contribution. But it’s the Roth 401(K) and Roth IRA that can help you minimize taxes in retirement. Because you fund Roth accounts with after-tax money, the growth on your investments and any withdrawals in retirement are tax-free.

While 401(k)s are typically limited to mutual funds, IRAs allow most investment types. Between these two retirement accounts, you have plenty of flexibility in how you choose to save for retirement.

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Prioritize all your financial goals

A retirement strategy is just one facet of your overall financial plan. It’s important to find a balance between saving for retirement and your needs today, which include other short-term savings goals. Other than your retirement savings, important financial goals include building an emergency fund and paying down high-interest debt.

How do you prioritize all your financial goals? Consider the following:

• No matter what, contribute to your 401(k) if it includes a company match. Employer contributions to a 401(k) are free money you get for saving toward your retirement. Contribute at least enough money to get the full match from your company.
• Pay off any high-interest debt before you dial up your retirement savings efforts. Using simple math, if the interest rate you’re paying on your credit card is higher than the returns on your investments, you’ll save more by eliminating that debt. As you contribute enough to your 401(k) to get the match, consider paying off any high-interest debt before you really focus on retirement.
• Save money for an emergency. Experts recommend saving enough to cover three to six months’ worth of essential expenses in case you lose your job. Whatever the amount you save, it’ll help you from turning to a credit card or high-interest loan to keep you afloat.

How much do you need in retirement?

How much do you think you'll need to have saved to retire comfortably?

About one in five (20%) say that they need $200K or less to be comfortable in retirement. However, about a third (31%) say they will need over a million.

Bottom line

Proper planning is key to saving enough money to sustain yourself during retirement. A retirement plan that considers your time horizon, risk tolerance and retirement lifestyle can help you get on track and stay on track as you build savings for later in life. Importantly, check in on your progress over time to ensure you’re still on track to hit your goals.

For an expert-built retirement plan that suits your unique situation, consider speaking with a reputable financial planner.

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Frequently asked questions about retirement planning

• What is the 4% rule for retirement?

  Created by financial adviser William Bengen in 1994, the 4% withdrawal rule is a popular retirement savings guideline. The rule states that retirees can safely withdraw up to 4% of their retirement savings each year, adjusted for inflation, without worrying about running out of money.

• What is the 25% rule for retirement?

  The 25% rule for retirement is an estimate of how much money you should save for retirement. According to the rule, you should have saved 25 times your planned annual withdrawals by retirement. For example, if you need to withdraw $65,000 each year from your retirement savings, you should have $1,625,000 saved by the time you retire.

• What is a good monthly retirement income?

  There is no one good monthly retirement income, as everybody's situation is different. Consider your preferred retirement lifestyle and figure out how much it'll cost to fund it. That may be a good monthly retirement income for you.