Retirement planning means far more than simply accumulating a nest egg for the years when you're no longer working. It involves developing a long-term investment strategy that helps you meet this critical goal without losing sight of your more immediate financial concerns, such as paying your mort gage or sending a child to college.
Where will nest egg come from?
Many retirement planning experts agree that you will need about 75 percent of your pre-retirement income to maintain your current standard of living in your retirement years. Therefore, before you can formulate a cohesive retirement plan, you need to determine what your sources of income will be in retirement.
Your Social Security benefits: These days, Social Security represents only a small portion of the income most retirees will need. According to a study done by the Employee Benefit Research Institute, individuals 65 years old or older whose post-retirement annual income was at least $50,000 would generally derive only 14 percent of their retirement income from Social Security.
Your company retirement plan: Past generations relied on company pension plans to take care of their retirement needs. While many companies still maintain defined benefit plans, many have switched to or added defined contribution plans, such as 401(k) plans. With a 401(k) plan, the responsibility is on you to contribute to the plan and determine how your savings will be invested.
If your employer offers a 401(k) plan, you generally have the ability to invest in a variety of professionally managed investment options. The earnings on the money you invest are tax deferred, so the entire amount can be reinvested in the plan to compound your return. Contributing to the plan can also give you immediate income tax savings. That's because 401(k) plans are salary-reduction plans, which means you do not have to pay income taxes on your contributions to the plan until you make a withdrawal. If you are eligible to participate, you may generally contribute up to $14,000 each year (depending upon the provisions of the plan).
Individual Retirement Accounts: If you don't have an IRA, you could be passing up a valuable opportunity to save for your retirement. Whether you choose a traditional IRA or a Roth IRA, the same basic tax-favored principle applies: every dollar of earnings can be reinvested to earn more without having to make current tax payments.
This powerful feature allows you to accumulate more assets than if you had invested the same dollars in a taxable account. As a result, an investment in an IRA is progressively worth more than the same amount invested in a taxable account.
The responsibility is yours
The majority of the income you'll need in retirement will most likely come from you. That's why it's vital that you take the time now to develop an intelligent, practical retirement plan that can help you meet your retirement income needs.
A good way to start is to participate to the fullest extent possible in a 401(k) plan (if your company provides one) and make annual contributions to an IRA. Both give your money the potential to grow on a taxdeferred basis.
There are many tools available to help you quantify your goals and implement your plans. By working with a professional financial adviser, he or she can help you develop a retirement plan that suits your particular goals and circumstances. Through education, patience and a disciplined approach to saving, you can achieve your ultimate goal of financial freedom in retirement.
Karandos is a financial advisor and a certified investment management analyst at UBS Financial Services Inc. in Indianapolis.Views expressed here are the writer's.