As we head into our golden years, retirement looms large. If we want to maintain our current and future level of living, we’ll need to do some careful planning, management, and investment of our resources while we’re still working or running a business.
Planning for retirement should begin early, when a person has a high-risk tolerance and can invest in risky assets like stock markets, hedge funds, and private equity, before shifting to safer investments like money market accounts, government bonds, and real estate as they get older.
Preparing for the change from earned income to retirement income is called retirement income planning. Social Security, part-time work, investments, annuities, and pensions are just a few available income replacement options.
Most Americans’ retirement savings depend heavily on Social Security. Roughly half of all retirees in the United States rely on Social Security for at least half of their income. For one in four retirees, it accounts for 90% or more of their annual income. However, for most working-age Americans, Social Security is not a sufficient source of income in old age.
After retirement, nearly every American will get a monthly check from Social Security. Inflation-adjusted payments are distributed to seniors every January, and this is one reason why Social Security benefits are so valuable: they are guaranteed to grow with inflation. If you delay starting Social Security benefits, you may be eligible to raise your monthly payments. Social Security payments are graduated according to how long you wait to begin receiving them, between ages 62 and 70.
You can put off paying taxes on your retirement savings and investment returns until you receive the money in retirement if you use a traditional 401(k) or individual retirement account (IRA). Employer contributions and 401(k) matches are features of several retirement savings programs that can speed up the savings process for retirement. However, each withdrawal from a regular IRA or 401(k) will be subject to income tax after you reach retirement age. After the age of 72, you must take a minimum amount out of your account each year or face a hefty tax penalty of up to 50%.
Roth 401(k)s and Roth IRAs allow investors to diversify their tax situation by prepaying income tax on a portion of their retirement funds. Once-tax contributions to a Roth IRA or 401(k) are eligible for tax-free withdrawals of principal and profits after the 59 1/2-year minimum holding period has elapsed. The money in a Roth IRA can continue to grow tax-free until it is either needed or passed on to the account holder’s beneficiaries, as there are no distribution requirements after retirement age is reached.
Only a tiny percentage of workers receive pensions, yet some jobs still do. In most cases, the income from a traditional pension will continue for the rest of your life or your spouse’s lives. Regardless of what happens to your private sector employer, the Pension Benefit Guaranty Corp. will stand by your pension plan and pay out any benefits owed to you by the plan’s insurer. Investing in an immediate annuity is one way people can build their own pensions using their assets.
As retirement nears, a common financial strategy is to transfer funds to safer investments. People who have maintained their health throughout their lives can anticipate a lengthy retirement. Maintaining a portion of your retirement fund in the stock market can help you increase your money over time and keep up with inflation in your later years. Though you should avoid investing money that you’ll need in the near future, you may choose to keep some of your retirement savings in the stock market if you have a high-risk tolerance.
Instead of investing in the stock market, you might instead invest in bonds, which tend to be more stable. Bonds offer a safe and steady way to generate income in retirement, with few options for loss. Inflation-protected securities (TIPS) issued by the United States Treasury are one type of bond that guarantees a return greater than inflation. Municipal bonds are only one example of a bond type that may help you save money on your taxes if you decide to hold on to them.
Some retirees work part-time because they enjoy their jobs and need income. Working past retirement age can help you enjoy life more, compensate for a lack of savings, and meet new people. In addition to the financial benefits of a 401(k) and health insurance, working after retirement may increase your eligibility for Social Security benefits.
With regular mortgage payments and an upward trend in property value, a homeowner can potentially profit from their equity.
Sale or second mortgage? It’s possible that you’ll have to sell the house to cash out the equity. It might be challenging to obtain a loan when your income drops, such as when you retire. But you never know if you won’t need a second mortgage (sometimes called a home equity loan or HELOC) after you retire. Alternatively, you can sell your current home and purchase a cheaper one if you decide that such a move is financially prudent.
Reverse mortgages: Although reverse mortgages exist, they should be carefully considered before being rushed into. Loans like that can be a concern depending on your living status and your plans for the family house after you pass away. Learn all you can about it, and give your full attention to mandatory counseling sessions. You should discuss your plans with anyone interested in the house, as this will allow them to offer input and help you spot any issues. Get clear from anyone who suggests a reverse mortgage as a means to pay for a financial service or investment.
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Buying an immediate annuity is a simple method to turn a large quantity of money into a steady source of income that will last for the rest of your life. Many retirees choose to invest their savings accumulated throughout their working years in an immediate annuity contract since the income stream begins once the contract is purchased, is predictable, and is unaffected by fluctuations in stock prices or interest rates.
In exchange for a guaranteed stream of income and a sense of safety, purchasers of instant annuities agree to have their purchasing power gradually eroded by the effects of inflation. The inability to change one’s mind after purchasing an immediate annuity is the primary cause of anxiety for most potential buyers. Your initial investment is protected for life, and the insurance company will keep any money left in your account after your death.
Annuities are complex financial instruments that can be purchased in various configurations. Learn as much as possible about it before making a hasty purchase.
The systematic withdrawal strategy involves withdrawing a predetermined percentage of your savings during your first year of retirement and then increasing that amount somewhat each year to account for inflation. You may have heard of the “4% rule,” which states that retirees should withdraw no more than 4% of their savings annually.
It has potential and might even work sometimes, but it also has some serious drawbacks. The 4% rule is based on assumptions about the future performance of your investments and the length of your retirement that may or may not come true. In the event of a severe decline in the value of your investments, you may need to reduce your withdrawal rate, while a rise in value could allow you to increase it. The 4% guideline is a good benchmark, but you should research and consider several alternatives before settling on a withdrawal rate that works best for you.
One way to plan for retirement is to divide your resources into three different “buckets,” or time periods, so they are easier to access. Its goal is to let your investments grow while letting you quickly access the money when needed. Your emergency fund and funds for essentials or large purchases within the next few years should go into the first jar. This cash should be easily accessible and not tied down by market fluctuations in a high-yield savings account.
The second container should contain the cash you expect to spend within the next three to ten years. Invest them in something more secure, such as bonds or CDs. Whenever you deplete the resources in the first bucket, you can replenish them by selling or withdrawing money from the assets in the second bucket.
Set aside a third container for funds you won’t need for at least ten years. Put the cash into high-yielding investments like equities. You should periodically liquidate some of these holdings and reinvest the proceeds in the second bucket’s safer investments.
The amount of money you get from Social Security after you retire is based on how much money you made while you were working and how old you are when you start getting benefits. If you want the maximum number of benefits to which you are entitled based on your work record, you must wait to start receiving them until you reach your full retirement age (FRA), which is either 66 or 67, depending on your birth year.
If you start early, your per-check advantage decreases. If your Full Retirement Age (FRA) is 67, you will receive 70% of your planned benefit every check at age 62. If your FRA is 66, you will receive 75%. On the other hand, delayed benefits can result in more money over your lifetime, but only if you live a relatively long time. If your FRA is 67, you may receive 124% of your scheduled benefit per check at 70; if it’s 66, you could receive 132% of your scheduled benefit per check at 70.
Most of the ideas we’ve talked about so far are geared toward retirement; at some point, the retirement fund is used to make money. However, the future beyond that point is unknowable. Insurance of the retirement income stream is the only option to reduce longevity risk for a customer. The customer works with an insurance firm and makes a single or joint premium payment in exchange for a stream of income for the rest of their life.
Evaluating the strategy entails striking a balance between the benefits and drawbacks, such as the certainty of income regardless of market performance or lifespan. Among the many variables to think about is the ease of access for the principal, the number of distributions to beneficiaries, the quality of the loan, and the costs.
Indeed, the aforementioned tactics are not all there is to try. Simply put, they give us a structure to work with when explaining the many options to our clients.
Knowing how the government taxes your savings accounts is essential if you want to keep more of your hard-earned cash. Tax-deferred retirement distributions are subject to ordinary income taxation. In contrast, withdrawals from Roth IRAs and Roth 401(k)s are tax-free, provided the account holder is at least 59 1/2 years old and has held the account for at least five years. Depending on your income level, you may be required to pay long-term capital gains taxes on the profits from your taxable brokerage account.
By keeping track of your tax bracket year after year and shifting your savings strategy to rely more heavily on Roth contributions as your tax rate approaches the top of the bracket, you can significantly cut your yearly tax bill. With a Roth conversion, you can turn some of your tax-deferred assets into tax-free savings in case you have a year with less income. When you reach the age of 72 or above, you need to keep track of your required minimum distributions (RMDs) or risk paying the penalty.
If you downsize your home, you may stretch your funds much further. You can downsize your current dwelling’s square footage, relocate to a cheaper neighborhood, or do both. If that’s not an option, consider renting out some additional space to help pay for your living costs.
In this case, you should consider your preferences and the financial implications. You may not be able to save much money by relocating if housing prices in your neighborhood have increased since you purchased your home.
Although you may not find yourself using every single one of these suggestions, you can stretch your retirement funds further by using even a few of them. Your retirement transition will go more smoothly if you give some thought to which of these options is best for you.
Having a steady source of income in retirement is possible, but it will take some planning. If you want to have a comfortable retirement, you need to save regularly, make smart investments, and plan carefully for how you will spend your money.