Regardless of what stage you are at in your career, preparing for retirement is a lifelong process involving investment strategies, understanding a 401(k), and managing your credit.
Although this may seem like a daunting endeavor, it’s important to prioritize retirement planning to avoid financial hardships later down the road. Retirement is a time where you should live comfortably, but doing so requires proactive planning.
Professionals in the C-Suite know better than anyone that the key to financial success is planning ahead. Take control of the present moment by setting the foundation to achieve your financial goals and plan a retirement that you look forward to with this accessible guide to preparing for retirement.
Save, Save and Save Some More
The key to saving is creating a detailed budget in which you account for all your expenditures.
Another factor to consider when saving is an emergency fund; most financial experts recommend saving six months’ worth of living expenses, to which you can dedicate a portion of your paycheck. A consistent method to save for retirement is to set up automatic payments towards savings and retirement accounts.
401(k)
The first step in retirement planning is investing in a 401(k) or another form of an employer-sponsored retirement fund. The great thing about these types of retirement plans is that they take advantage of compound interest so that your savings increase in value over time. Another benefit of contributing to your 401(k) is that you aren’t typically required to pay taxes on your contributions until you reach the age of your retirement. Contributions are automatically deducted from your paycheck.
Some 401(k) programs offer a matching contribution, meaning they match your contributions to your 401(k) – AKA free money! The general rule of thumb in terms of contributions is dedicating 20% of each paycheck towards savings in general, including your retirement savings.
Since the 30s are typically peak income years, this is a great time to increase your 401(k) contributions – especially if your employer matches your contributions. If you are unable to reach the 2021 maximum contribution of $19,500, aim to get there within a couple of years. For extra savings, consider automatically increasing your contributions by 1% annually.
Note that if you’re age 50 or older, you are allowed to put in an extra yearly catch-up contribution of $6,500. This brings the 2021 maximum contribution amount from $19,500 to a total of $26,000.
Individual Retirement Account (IRA)
If a 401(k) isn’t available to you, there’s always the option to open an individual retirement account, also known as an IRA. One benefit of this method is that they do not need to be obtained through an employer and therefore provide additional investment options.
For increased retirement savings, it’s common for people to have both an IRA and a 401(k). IRAs come in two forms: a traditional IRA or Roth IRA. This begs the question: what’s the difference?
Roth IRA
To avoid paying taxes or penalties when you withdraw your retirement funds, opt for a Roth IRA where taxes are already drawn from your contributions preemptively. This means that your retirement contributions are post-tax. Here are some additional need-to-knows of the Roth IRA:
- Doesn’t include the current-year tax benefits
- 2021 Contribution limit for 2021 is $6,000 unless you’re over the age of 50 and eligible for catch-up contributions, which makes your limit $7,000
- For the 2021 tax year, your contribution eligibility income must be below $140,000
- For penalty and tax-free withdrawals, wait for 5 years of contribution or until your age reaches 59.5
- No mandatory distribution requirements
- No time restriction for when you can dip into the account
- If you only plan to use your Roth IRA for retirement, it’s best not to use the funds until retirement.
Traditional IRA
As you can probably guess, traditional IRA accounts consist of pre-tax contributions. This means you can save on taxes while you anticipate your retirement. However, be sure to note that when you do withdraw from your retirement fund, taxes will be deducted. Here are some additional factors to consider when it comes to a Traditional IRA:
- Obtain immediate tax benefits because you save tax dollars with every contribution
- 2021 Contribution limit for 2021 is $6,000 unless you’re over the age of 50 and eligible for catch-up contributions, which makes your limit $7,000
- No limitations to contribution eligibility and open to anyone with earned income
- Penalty-free withdrawals but taxed based on current income and tax bracket after the age of 59.5
- After age 72, mandatory distributions are required
How to Decide Between a Traditional vs. Roth IRA
Deciding between a traditional or Roth IRA comes down to your tax situation. Those with a higher expected income tax bracket should open a Roth IRA to pay taxes upfront while they are lower. This also means that you would pay more in taxes if you’re in a lower income bracket, so those in this boat should opt for a traditional IRA so as to pay taxes on future withdrawals.
The concept of catch-up contributions also applies to IRA accounts, ultimately amounting to $1,000 on top of the typical limit of $6,000 at age 50: creating a total of $7,000. For married folks, you and your spouse are eligible for catch-up contributions.
How to Decide Between a 401(k) or IRA
If your employer matches your contributions to your 401(k), you should take advantage of this since it can significantly grow your retirement savings even though you are still required to pay taxes on withdrawals later down the line.
Conversely, IRAs offer more investment options since they are managed by a broker. However, many financial experts suggest investing in both a 401(k) and an IRA to get the benefits of both and maximize your retirement savings.
Fix Your Credit
It’s extremely important to have a strong credit score to make the bigger purchases in life like a house, car or a loan. High credit scores ultimately result in higher limits on credit cards while they have lower interest rates for car loans, mortgages, as well as car and home insurance.
Pay off Your Debts
One way to improve your credit score is to pay off your debts. Some approach paying off debt as another investment. According to financial experts, there are two types of debt: good and bad debt.
Good debt consists of things like a mortgage because the house will ideally increase in value and you’re on the path to owning the property. This means that the debt you owe ends up being a financial advantage in the long run. Unfortunately, bad debt consists of items like a car loan because it is a depreciating asset: it loses value as time goes on. In addition, credit card debt is also considered bad because of its high interest rates yet low tax advantages.
On the priority list of what debts you have to pay off, it’s wise to pay off bad debt first: this includes credit card debt, student loan debt, or car loan debt.
Consider Investing
Creating a portfolio of assets when it comes to investment means that you can benefit from compound interest. Individuals in their 40s and above could benefit from investing more aggressively in stocks or index funds can help you reach a higher rate in return before you reach your age of retirement.
Index funds are a great way to start investing because they’re less risky than regular stocks which depend on the success of a single company; index funds provide exposure to stocks from a variety of industries – all from one fund. Ultimately, this can help you achieve a low-cost yet diversified portfolio of investments that yield profitable returns, unlike conservative investments like bonds.
Keep Healthcare Costs in Mind
A large portion of many individuals’ retirement funds ends up going towards medical bills that can quickly subtract from your savings. In 2020, Fidelity Investments estimated that a couple in their mid-60s can anticipate $285,000 in healthcare costs during retirement.
This is where a Health Savings Account (HSA) from your employer can come in handy. When you add money to this account, it lets you reduce your taxable income and grow your savings tax-free. Not only this, but it can cover some medical premiums and allow catch-up contributions for those older than 55.
However, if an HSA isn’t available to you, there are other options. Long-term care insurance is a type of private insurance that typically covers nursing-home and home-healthcare for folks over the age of 65, or if they have a chronic condition that needs full-time care. Although it is available to everyone who can afford it, the average annual premium for a healthy 55-year-old couple was $3,050 in 2020.
When deciding on your long-term health care plans, some important things to consider include but aren’t limited to, your general health, genetic history, or the likelihood of paying for a nursing home or at-home care. Planning ahead can help you reduce the significant costs of retirement healthcare.
Overall, preparing for retirement is something we all should do regardless of our position. CEOs have an intricate understanding of planning for the long-term, so many of these points may not be new to you. However, we hope you came away with some knowledge on long-term finances for a comfortable retirement.
