Essential Guide to Planning for Your Retirement
No one’s path to retirement looks the same. Whether you’re already on track to retire in your mid-50s, or you're just hoping to stop working before your 75th birthday, many of the decisions you make will depend on your individual financial circumstances.
Regardless of where you stand, here are some tried-and-true strategies and questions that can help you think about how to plan for your eventual retirement, including when to call in a pro to help get you there.
Where Do You Start Building Your Nest Egg?
Even if you’re a veteran saver who loves to give your high-yield savings account a workout, the specifics of where and how to set money aside for retirement can be confusing. There are several retirement account options, including tax-deferred or advantaged retirement accounts and investment accounts.
Tax-deferred retirement accounts
Tax-deferred retirement accounts help you set aside money for your future while reducing your federal income tax burden today. You pay taxes on the money when you withdraw it.
You may be eligible for an employer-sponsored tax-deferred retirement account such as a 401(k), 403(b), or a 457 plan. As a perk, some employers match your contributions up to a percentage of your income (which you should try to take advantage of). Alternatively, you may be eligible to open an individual retirement account (IRA). Both options allow you to contribute pre-tax dollars to your retirement account, where the money will grow tax-free–although you will have to pay income tax on withdrawals. As an incentive to keep that money in the tax-deferred retirement account until you retire, the IRS levies a 10% fee on withdrawals you make prior to age 59½ (with a few exceptions to tax on early distributions.)
The 2023 contribution limit for IRAs is $6,500 for those under 50, and $7,500 if you’re over 50. Employer-sponsored retirement accounts have a 2023 contribution limit of $22,500 if you are under age 50, and up to a total of $30,000 if you are 50+.
Tax-advantaged retirement accounts
Just like tax-deferred retirement accounts, Roth IRAs and Roth 401(k) accounts allow you to set money aside for retirement. But you make contributions to Roth accounts with money you have already paid income tax on. Generally, the money grows tax-free, and withdrawals are also tax-free provided you have held the account for at least five years or have reached age 59½.
The Roth versions of 401(k) accounts and IRAs have the same contribution limits as their traditional counterparts. However, the contribution limits are aggregate limits, which means you cannot contribute the full amount to each account if you have more than one of each type. For example, if you're under age 50 and have both a traditional and a Roth IRA you generally cannot contribute more than $6,500 total between the two IRAs.
There are also income limits on Roth IRA contributions, and you should consult with your tax advisor for specific guidance. Generally, as of 2023, individuals with an adjusted gross income (AGI) of $138,000 and married couples filing jointly with an AGI of $218,000 can contribute up to the limit to a Roth IRA. Individuals making between $138,000 and $153,000 and married couples making between $218,000 and $228,000 can contribute a reduced amount. Above those upper income limits, you cannot make a Roth IRA contribution. Roth 401(k) accounts have no income limits, however.
You can open a Roth 401(k) account with your employer if the plan offers Roth contribution options. You can also open a Roth IRA through a bank or brokerage account.
A Roth account can be an excellent fit for someone whose income is lower than they expect it to be in the future. Since your income taxes will increase with your income, setting aside post-tax money while your income is lower gives you the best bang for your Roth contribution buck.
Taxable investment accounts
If you maximize your tax-deferred and Roth contributions, hope to retire before age 59½, or simply want to have access to some of your investments anytime, a taxable investment account can be a good addition to your retirement plan.
You can open a taxable investment account through a brokerage or robo-advisor. Money invested in a taxable account has fewer restrictions and regulations than a retirement account. You can withdraw funds at any time for any purpose. This can make a taxable investment account a good option for either long-term savings (such as saving for a down payment) or for early retirement spending.
That said, it’s smart to have a well-defined tax strategy for your investment account. Planning ahead for any taxes you owe on capital gains–including using capital losses to offset those gains–can help ensure you don’t underestimate your tax burden.
How Much Should You Save for Retirement?
There are several strategies you can use to help pinpoint your retirement savings “number” as you work to build your nest egg.
Start with these basic rules of thumb.
Early retirement planning is next to impossible to do with any accuracy. Even if you're decades away, it’s still a good idea to have a savings number to aim for so you can start calculating how you'll get there. These two simple rules of thumb can help:
Percentage of income: Generally, experts suggest using 80-90% of your current annual income as a starting point for determining your annal retirement income. For example, if you earn $75,000 per year, you would plan for $60,000 to $67,500 of annual spending in retirement. Alternatively, you could calculate how much you expect to spend on an annual basis in retirement and use that figure instead.
Multiply by 25: Once you have your retirement income (or expected spending) roughly calculated, multiply that amount by 25. This calculation gives you a retirement savings number, or nest egg, you can aim for that will allow you to safely withdraw 4% per year to live on. For instance, if you are planning on living on $60,000 per year (excluding any potential Social Security benefits), you would want to try to retire with about $1.5 million in savings.
Assuming your nest egg grows by at least 4% per year (historically, the market has provided an average annual return of 6% to 7%), withdrawing no more than $60,000 annually will theoretically allow your $1.5 million to last forever. And rather than trying to figure out your life expectancy, you could instead feel confident that you’ll leave your family a comfortable legacy.
Before you panic at the thought of having to save $1.5 million, remember you're going to be taking advantage of the power of compounding interest. Investing just 10% of your annual $75,000 income with an annual return of 7% per year will grow a nest egg from $0 to $1.04 million in 35 years. Increase the amount you invest or the length of time you're invested, and your nest egg increases. The sooner you're able to pay off high-interest debt, the more money you'll have available to invest over a longer period of time.
It’s also entirely possible to comfortably retire on much less. That’s why these rules of thumb should only give you a rough number to aim for. To figure out more precisely how much you can expect to live on, you’ll need to dive into your own specific circumstances.
Make specific calculations as you get closer to retirement.
As you get closer to retirement, you will need to make more specific calculations and decisions. These will include:
Market exposure: Do you have principal-protecting stable assets in your portfolio? If you are only invested in higher-risk/higher-reward assets as you near retirement, you’re vulnerable if there’s a market downturn right before or right after you retire. Make sure your market exposure includes assets that will maintain your principal even in the face of volatility.
Planned expenses: Are you retiring to a small town or will you travel the world? Will anyone depend on you financially or will you be footloose and fancy free? No matter what expenses or savings you can expect in retirement, start budgeting for the specific ways you plan to spend money as you near retirement.
Inflation: As you get closer to retirement, you’ll want to calculate how inflation may affect your nest egg. Investing a portion of your money for long-term growth, even if you intend to retire soon, can help counteract inflation.
Healthcare expenses: The cost of healthcare can be a wildcard when it comes to retirement planning, in part because your health can change. Planning for medical expenses as you near retirement–and not decades in advance–will give you a better sense of how much you may need.
Factor in early retirement savings vs. long-term retirement savings
You may not need access to all your retirement savings on the day you retire. While there are different income and tax implications with different kinds of retirement savings products and approaches, you could invest your money based on when you expect to need it. This approach is called the "bucket" method.
With the bucket method, you allocate investments based on when you need them within various retirement savings products. You can further strategize when you will withdraw money from each type of account to make sure you’re minimizing your tax burden.
How the bucket method works
The first bucket will be money you expect to spend in the first few years of retirement. You want this money invested in stable assets, such as a certificate of deposit account, a money market account, or in U.S. Treasury bills.
The second bucket will hold money you may need in years five through 15. You can be a little more aggressive since you have the time to wait out market fluctuations, but you’ll want to focus on generally stable investments, such as bonds.
The last bucket is for money you won’t need until you’ve been retired 15 or more years. With that timeframe, you can afford to invest more aggressively in higher-risk/higher-return assets like stocks. This portion of your nest egg can keep growing even after you have retired.
Each year of your retirement, you will rebalance your portfolio, reallocating money to the various buckets as necessary. When you have spent down your first bucket, you can transfer money from the second bucket to it for near-term expenses, while transferring some of your third bucket market gains to your second bucket.
Should You Partner with a Financial Professional?
Not all financial professionals offer the same services. Understanding the various types of financial planning professionals you may encounter can help you determine if you want to work with a pro or do it yourself. Here are some of the most common types:
Financial planner: A financial planner can help you create and implement a retirement plan. It’s generally best to work with a Certified Financial Planner (CFP), since these planners must earn and maintain certification. Unlike some financial advisors, all CFPs are held to a strict standard of fiduciary duty, meaning they must put your financial best interests ahead of any commission they may make by selling a certain financial product.
Insurance agent: An insurance agent can help you purchase life insurance or annuity products as part of your retirement plan. Remember that insurance agents generally work on commission, and that could affect their recommendations.
Registered investment advisor (RIA): RIAs offer investment advice and portfolio management under a fiduciary standard, meaning they are legally required to put their clients’ interests above their own. Generally, RIAs tend to work with high net worth individuals with complex financial situations.
Registered representative: Commonly called stockbrokers, these professionals are licensed to buy and sell securities. Registered representatives typically work for a broker-dealer.
Accountant: A certified public accountant (CPA) can help with tax preparation and tax planning for retirement.
How Do You Plan for Taxes in Retirement?
Taxes in retirement can sometimes be more complex than they were when you were working. This is why some retirees choose to work with an accountant.
If you have set money aside in tax-deferred retirement accounts, you can expect to pay your ordinary income tax rate on any withdrawals you make. You will also have to take annual required minimum distributions (RMDs) from your tax-deferred accounts after reaching age 73–and you will owe taxes on each year’s RMD. (Per the SECURE 2.0 Act of 2022, the RMD age will rise to 75 in 2033). The RMD is calculated based upon your account balance and your age, and you must withdraw no less than the RMD or face tax penalties. However, you are free to take more than the RMD amount, but you will owe taxes on whatever amount you withdraw.
You may also have to pay taxes on your Social Security benefits. To determine your tax rate, the IRS adds together half of your annual Social Security benefits plus all your taxable income (not including money withdrawn from a Roth account). If the total is higher than $25,000 for an individual or $32,000 for a married couple, you will owe taxes on your Social Security benefits.
How Much Will You Spend on Healthcare in Retirement?
Finding ways to plan for your future healthcare costs can take some of the pressure off your retirement budget. No one knows for sure, of course, but your current health, parents’ longevity, and health history can offer clues about what those costs could look like. For a general idea, Fidelity estimates that the average 65-year-old couple who retired in 2022 will spend $315,000 on healthcare in retirement.
Pre-retirees should familiarize themselves with Medicare prior to reaching age 65. Understanding what your options are within Medicare before you must sign up can help you find the best plan for your needs.
If you have access to a high-deductible health plan, you can also start setting money aside in a health savings account (HSA) for future healthcare expenses. You can deposit pre-tax money into the HSA, where the funds grow tax-free and can be withdrawn tax-free for any qualifying medical expense. For 2023, individuals can deposit up to $3,850 and families can deposit up to $7,750 annually into an HSA. The money rolls over from year to year and can be used anytime.
Alternatively, a Roth IRA could be another option for future healthcare costs since you can access that money tax-free. You can withdraw money for medical expenses from your Roth account without affecting your taxes.
The Bottom Line: Best Practices for Retirement Planning
Planning your retirement is a long process, but there’s no need to feel bogged down by complexity. Follow these steps to prepare for your retirement, no matter how far away it may be.
Open a retirement account as soon as you can and set up recurring contributions.
Pay off high-interest debt so you have more money available to invest.
Invest for the long term. Give compounding interest time to work its magic.
Know when to call in the pros. Consulting financial professionals can help you make and stick to your plan.
Plan for taxes and healthcare.
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