Every day we receive wonderful, inspirational messages and quotable quotes on social media about aging gracefully, and staying positive through the Golden Years.
While these are no doubt stirring and uplifting, very few of them talk about the financial aspect of aging.
But unless we plan for retirement, we will find it difficult to meet expenses and also live a peaceful life.
The rat-race seldom gives us the time or leisure to think about life when we stop running. But these are really the years when you can build a nest egg that will tide you over the fallow period in your life.
No matter when the thought strikes you, it’s never too late to wonder how you’re going to fund your retirement.
Why Is Retirement Planning Important?
Planning for the years when you don’t have a regular income is beneficial from a personal and a societal point of view. Retaining financial independence is important to avoid being subservient to your family or on the government.
Since you’re not actively employed, you have the leisure to pursue hobbies, travel and also volunteer or study. However if you don’t have financial resources, accessing these things can become a pain point.
Retirement planning is important because:
- No one can continue to work endlessly
- Life-expectancy has gone up due to better healthcare and nutrition and you can expect to live longer
- Age-related health issues increase
- You need a stress-free old age
- It prevents you from being dependent on your kids or on Social Services
- You want to fulfill certain dreams and aspirations
- It makes your money work for you when you no longer can
- You can avail of tax benefits if you plan correctly
- Helps you beat inflation
Retirement Plans
When it comes to planning, there are plenty of options available. They include those provided by employers, set up by government, insurance companies, trade unions, financial institutions and others.
There is no one-size-fits-all plan, and it’s important to select the one that best aligns with your financial goals, job situation, personal and family situation and future aspirations.
They include defined contribution and defined benefit plans, hybrid and cash balance plans, qualified and non-qualified retirement plans, simple individual retirement account (IRA), simplified employee pension individual retirement account (SEP IRA), and many more.
You can avail of certain accounts such as the 401(k), solo 401(k), 403(b), 457(b), IRA and Roth IRA, Self directed IRA and more.
There are pros and cons that go with each one of these and you can select the one that suits you best.
What Is the 401(k)?
One of the popular and most common options in retirement planning is the 401(k) account. Though it’s available only in the US, it serves as a benchmark for retirement plans in many other countries across the world. It gets its name from the relevant subsection 401(k) of the Internal Revenue Code.
It is an employer-sponsored plan that enables retirement saving in a tax-sheltered method so that you can maximize the value of your retirement funds.
The employee contribution is equally matched or non-electively contributed by the employer and it is a defined contribution plan. Under this plan, certain eligible employees can make tax-deferred contributions from their current salary/wage. The employee contribution is completely tax-free, but the employer contribution is made pre-tax. Employers can also add a profit-sharing feature. The full benefits are realized only on retirement and withdrawals are not permitted before this.
The Roth 401(k) is a variation on the traditional 401(k) and it carries certain advantages that your financial adviser can apprise you about. They can also give you more information on Roth 401(k) vs Roth IRA.
How much money should you have in your 401(k) when you retire?
The simple answer to this is that you must aim to replace at least 80% of your earnings that are pre-retirement by your post-retirement savings. This would include all the sources of income and not just from your retirement plan.
Some financial experts recommend that by the time you’re 30, you should have saved the equivalent of your salary, by 40 three times, by 50 six times, by 60 eight times and by 67 you should have saved at least 10 times your salary. This is leveraged by the power of compound interest and also by the percentage of salary that your employer can match.
While these figures are quite general and based on certain studies and averages, your unique circumstances may be different.
The standard assumption about retirement funds is based on your current job, projected retirement age and financial goals. Assuming that you have saved $1 million, and the interest rate you can avail of is 5%, you can be assured of $50,000 a year. Every million more that you’re able to save fetches you a corresponding increase in annual income.
You can start withdrawing money from your 401(k) plan when you cross age 59.5. If you start working at the age of 22, and continue working up to age 65, you would have worked for 43 years.
Savers who started young and have high savings capacity may have been able to save around $8 million. Older people and low-end savers who started saving later may have around $1 million.
Keeping these numbers in mind, the average 60-year-old would most probably have between $800,000 and $5million in their 401(k). This figure is also dependent on the company’s matching contributions and the performance of the investments made.
Retirement funds such as the 401(k) should be focused on capital preservation and not in making risky investments. Starting early is the best way to accumulate funds because at that stage, your expenses may not be very high and your savings capacity is more. This also means that you can save smaller quantities more regularly.
The 401(k) is beneficial because of the employer match feature. That’s why it’s important to stay employed for as long as possible with an employer who offers this plan. It’s a good rule of thumb is to have 15% of your pre-tax income including employer match in your 401(k).