Throughout your career, retirement planning will likely be one of the most important components of your overall financial plan. Whether you have just graduated and taken your first job, are enjoying your peak earning years, or are preparing to retire, your retirement plan can play a key role in your financial strategies.
Years ago, one typically worked most of their life for a single, large employer who would then reward them with a pension, at retirement, for their years of hard work and loyalty. “Retirement planning” meant figuring out how to use your free time. Today, in all likelihood you will not be receiving a pension and instead will be living in retirement on money you, yourself, saved. So how should you view and manage your retirement savings plan through various life stages? The following are some points to consider.
Just starting out –
If you are a young adult, just starting your first job, chances are you face a number of different challenges. College loans, rent, & car payments all may be competing for your hard-earned, yet still entry -level paycheck. How can you even consider setting aside money for retirement? After all, retirement is decades away–you have plenty of time, right?
Before you answer, consider this: The decades ahead of you can be your greatest advantage. Through the power of compounding, you can put time to work for you. Compounding happens when your contribution dollars earn returns that are then reinvested back into your account, potentially earning returns themselves.
Example(s): Say at age 20, you begin investing $3,000/year for retirement. At age 65, you would have invested $135,000. If you assume a 6% average annual return, you would have accumulated a total of $638,231 by age 65. However, if you wait until age 45 to begin investing that $3,000 annually & earn the same 6% return, by age 65 you would have invested $60,000 & accumulated a total $110,357. Even though you would have invested $75,000 more by starting earlier, you would have accumulated more than half a million dollars more overall.(1)
That’s the power you have as a young investor – the power of compounding & time. Even if you can’t afford to contribute $3,000/ year ($250/month) to your retirement, remember that even small amounts can add up through compounding. So contribute whatever you can, & then try to increase your contribution amount as debts are reduced or paid off. In addition, time offers an additional benefit to young adults–the potential to withstand stronger short-term losses in order to pursue higher long-term gains. That means you may be able to invest more aggressively than your older colleagues, placing a larger portion of your portfolio in stocks to strive for higher long-term returns.(2)
Reaching your peak earning years –
The latter stage of your career can bring a wide variety of challenges & opportunities. Older children typically come with bigger expenses. College bills may be making their way to your mailbox or inbox. You may find yourself having to take time off unexpectedly to care for aging parents, a spouse, or even yourself. As your body begins to exhibit the effects of a life well lived, health-care expenses begin to eat up a larger portion of your budget. And those pesky home & car repairs never seem to go away.
On the other hand, with 20+ years of work experience behind you, you could be reaping the benefits of the highest salary you’ve ever earned. With more income at your disposal, now may be an ideal time to kick your retirement savings plan into high gear. If you’re age 50 or older, you may be able to take advantage of catch-up contributions, which allow you to contribute up to $6,500 in your IRA or $24,000 to your employer-sponsored plan in 2016, versus a maximum of $5,500 and $18,000 respectively, for most everyone else. (Some plans impose different limits.)
Preparing to retire –
With just a few short years until you celebrate the major step into retirement, it’s time to begin thinking about when & how you will begin drawing down your retirement plan assets. You might also want to adjust your investment allocations with an eye towards asset protection (although it’s still important to pursue a bit of growth to keep up with the rising cost of living).(3) A financial professional can become a very important ally in helping to address the various decisions you will face at this important juncture.
Other considerations –
Throughout your career, you may face other important decisions involving your retirement savings plan. For example, you may want to review the differences between Roth contributions and traditional pretax contributions to determine the best strategy for your situation. While pretax contributions offer an upfront tax benefit, you’ll have to pay taxes on distributions when you receive them. On the other hand, Roth contributions do not provide an upfront tax benefit, but qualified withdrawals will be tax free.(4) Whether you choose to contribute to a pretax account, a Roth account, or both will depend on a number of factors.
Finally, as you make decisions about your plan on the road to retirement, be sure to review it with your advisor, alongside your other savings and investment strategies. While it’s generally not advisable to make frequent changes in your retirement plan investment mix, you will want to review your plan’s portfolio at least once each year and as major events (e.g., marriage, divorce, birth of a child, job change) occur throughout your life.
(1)This hypothetical example of mathematical principles does not represent any specific investment & should not be considered financial advice. Investment returns will fluctuate & cannot be guaranteed. (2) All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful. Investments offering a higher potential rate of return also involve a higher level of risk.(3) Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against a loss.(4) Qualified withdrawals from Roth accounts are those made after a five-year waiting period and you reach age 59½, die, or become disabled.
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