By Stephan Scribner
How do you picture your retirement? Traveling
the country in a motorhome or staying
at resorts several times a year? Perhaps it is
finally being able to travel to those destinations
you’ve dreamed of your whole life.
Quite often, our idealistic vision of what
the future might hold isn’t realistically
thought out in practical terms of how we
might actually realize that vision. We should
ask ourselves: How do we practically pursue
realizing our dreams?
Estimate your retirement income needs.
They say you cannot manage what you
cannot measure, so it is helpful to determine
what your retirement income needs might
look like. It’s quite common to discuss annual
retirement income as a percentage of
our current income, but the percentage is
not a set pre-determined amount.
Many financial advisors provide a 60 to 80 percent rule of thumb of your final working year’s income to maintain your current standard of living in retirement. Recent estimates suggest people may need up to 80 percent of their pre-retirement income in retirement.
There are numerous factors to consider as you work towards calculating that percentage, including lifestyle in retirement, health issues and health coverage in retirement, whether your mortgage is paid off, and how long until you plan on retiring. If you’re nearing retirement, the gap between your current expenses and your retirement expenses may be negligible. If you are many years away from retirement, the gap between the two may be significant, and it can be more difficult to determine these future expenses.
Remember to also take inflation into account. The average annual rate of inflation over the past 20 years has been approximately 2.4 percent. (Source: Consumer price index (CPI-U) data published by the U.S. Department of Labor, 2012.) A realistic estimate of your expenses will tell you about how much yearly income you’ll need to live comfortably.
Calculating your retirement income gap Once you have estimated what your retirement needs might be, you need to do a thorough review of your estimated future income and the assets at your disposal. This is often called a Retirement Needs Analysis.
Social Security income may contribute to future income as would a retirement plan from your current employer, working part time in retirement, and possibly other sources. If there is a gap between what your retirement needs might be and what you estimate will be available, other retirement funding will need to come from retirement savings.
Saving for retirement:
The rule of thumb on saving for retirement is that it is never too early to begin. Start saving in your 20s and with interest compounding you can have a decent nest egg when you plan to retire. A good plan of action is to have certain amounts taken directly from your paycheck and automatically deposited into accounts you choose such as employer-sponsored 401(k) plans and payroll savings plans. Annual cost of living raises can be automatically included, which helps fight the temptation to increase your standard of living with each bonus or increase in salary.
Understand the investment options available. It is necessary for you to understand the various types of investments available to you in achieving the retirement you envision for yourself. If you don’t have the time, energy, or wherewithal to perform the necessary research and education in regards to your investment options, hiring a professional is advised. A financial professional has been trained and licensed in the various investment vehicles available and can help explain these to you, taking into account your personal risk tolerance, suitability for certain products, investment time horizon, and other factors.
Along with those already mentioned, a few of the more common retirement savings vehicles are:
Annuities, which are contracts issued by insurance companies, can be a good savings vehicle. Some annuity features include principal and interest rate guarantees, tax advantages through tax deferral, accumulation of funds without market risk, and income protection during retirement through flexible payout options. Some annuities also come with long term care rider features, which can bring peace of mind.
IRAs also feature tax deferral. The most common types of IRAs are Traditional IRAs and Roth IRAs. Both plans can invest in stocks, bonds, mutual funds and other assets and allow penalty-free withdrawals after age 59 Â½. While Roth IRAs allow eligible distributions tax-free, eventual withdrawal from an IRA is taxed as income, including the capital gains. The thinking is that because income is likely to be lower after retirement, your tax rate may be lower. Combined with potential tax savings at the time of contribution, IRAs can prove to be a very valuable tax management tool for individuals.
Scribner is a financial consultant with BSNB Financial Services.
Photo Courtesy of Ballston Spa National Bank