What Is Retirement Planning? Steps, Stages, and What to Consider

What Is Retirement Planning?

Creating a retirement plan begins with determining your long-term financial goals and tolerance for risk, and then starting to take action to reach those goals. The process can begin any time during your working years, but the earlier the better.

The process of creating a retirement plan includes identifying your income sources, adding up your expenses, putting a savings plan into effect, and managing your assets. By estimating your future cash flows, you can judge whether your retirement income goal is realistic.

Needless to say, a retirement plan is not a static document. You'll need to update it from time to time as well as review it to monitor your progress.

How Retirement Planning Works

A retirement plan is your preparation for a good life after you're done working to pay the bills, or at least done working a full-time job. But it's not all about money.

The non-financial aspects include lifestyle choices such as how you want to spend your time in retirement and where you'll live. A holistic approach to retirement planning considers all these areas.

The goals for your retirement plan will change in focus over time:

• Early in a person’s working life, your contribution to retirement savings may be modest. The reward is 40-plus years of investment growth.
• During the middle of your career, when your income may be at its peak, you might set specific income or asset targets and take steps toward achieving them.
• Once you reach retirement age, you go from accumulating assets to what planners call the distribution phase. You’re no longer paying into your retirement account(s). Instead, you start collecting the rewards of decades of savings.

How Much Do You Need to Retire?

Your magic number, which is the amount you need to retire comfortably, is highly personalized. But there are rules of thumb that can give you an idea of how much to save.

• People used to say that you need around $1 million to retire comfortably.
• Other professionals use the 80% rule, which states that you need 80% of your current income to live comfortably after retiring. So if you made $100,000 per year, you would need savings that produce $80,000 per year for roughly 20 years, or a total of $1.6 million.
• Others say most of us aren’t saving anywhere near enough to meet those benchmarks and should adjust our lifestyles accordingly.

Estimating Expenses

Your post-retirement expenses largely determine that "magic number."

It's a good idea to create a retirement budget, calculating estimated costs for housing, health insurance, food, clothing, and transportation.

And since you'll have more free time on your hands, you may also want to factor in the cost of entertainment, hobbies, and travel.

It may be hard to come up with concrete figures, but a reasonable estimate will be helpful.

Steps to Retirement Planning

Regardless of where you are in life, there are several key steps that apply to almost everyone during their retirement planning. The following are some of the most common:

1. Come up with a plan. This includes deciding when you want to start saving when you want to retire, and how much you'd like to save for your ultimate goal.
2. Decide how much you'll set aside each month. Using automatic deductions takes away the guesswork, keeps you on track, and takes away the temptation to stop or forget depositing money on your own.
3. Choose the right accounts for you. Invest in a 401(k) or similar account if your employer offers that option. If the company offers an employer match and you don't sign up, you're giving away free money. Whether or not there's an employer match, you're getting a good deal tax-wise.
4. Check on your investments from time to time and make adjustments. This is especially important after a big event, like marriage or a baby.
   

Retirement Plans

Tax-advantaged retirement savings plans have become the keystone of long-term savings for Americans. You should have access to one or more of these plans depending on how you earn a living. Each has its own rules and regulations.

Employer-Sponspored Plans

Most large companies offer their employees 401(k) plans. Nonprofit employers have similar 403(b) plans.

An up-front benefit of these qualified retirement plans is that your employer has the option to match what you invest up to a certain amount. For example, if you contribute 3% of your annual income to your plan account, your employer may match that amount, depositing the sum into your retirement account along with your contribution.

You can contribute more than the amount that will earn the employer match. Some experts recommend contributing upwards of 10%.

401(k) Limits

The maximum is revised yearly by the IRS Participants can contribute up to $23,000 in 2024 to a 401(k) or 403(b), some of which may be added to with an employer match. People over age 50 can contribute an extra $7,500 per year as a catch-up contribution in 2024.

These accounts can earn a much higher rate of return than a savings account (although the investments are not free of risk). The funds in the account, if it is a traditional account rather than a Roth account, are not taxed until you withdraw them. Since your contributions are taken off your gross income, you will get an immediate income tax break.

Those who are on the cusp of a higher tax bracket might consider contributing enough to lower their tax liability.

Traditional Individual Retirement Accounts (IRAs)

The traditional individual retirement account (IRA) is similar to a 401(k) plan but it can be obtained at virtually any bank or brokerage. It is primarily for self-employed people and others who have no access to a 401(k), but anyone with earned income can invest in an IRA.

The money you save in an IRA is deducted from your income for the year, lowering your taxable income and, therefore, your tax liability.

The tax benefit to this kind of account is upfront. So when it comes time to take distributions from the account, you are subject to your standard tax rate at that time. Keep in mind, though, that the money grows on a tax-deferred basis. There are no capital gains or dividend taxes that are assessed on the balance of your account until you begin making withdrawals.

IRA Limits

The IRS sets limits on how much you can contribute to a traditional IRA each year. The limit for 2024 is $7,000. People who are 50 and older can invest an additional $1,000 for a total of $8,000 in 2024.

Distributions must be taken at age 72 and can be taken as early as 59½. You will owe taxes on the withdrawal at your regular income tax rate for that year.

Roth Individual Retirement Account (IRA)

A Roth IRA is funded with post-tax dollars. This is a great variation on the IRA, with a little more pain upfront for a lot of gain down the road.

The Roth IRA eliminates the immediate tax deduction of the traditional IRA. The money you pay into it is taxed in that year.

However, you should owe no taxes when you start withdrawing money, either on the amount you put in or the investment gains it accrued.

Starting a Roth IRA early can pay off big time in the long run, even if you don’t have a lot of money to invest at first. Remember, the longer the money sits in a retirement account, the more tax-free interest is earned.

Roth Limits

The 2024 contribution limit for either IRA (Roth or traditional) is $7,000 a year, or $8,000 if you are over age 50. A Roth has other restrictions, related to income. For instance:

• A single filer can contribute the full amount only if they make $146,000 or less annually, as of the 2024 tax year.
• After that, you can invest to a lesser degree, up to an annual income of $161,000 in 2024.

Note that the income limits are higher for married couples filing jointly.

As with a 401(k), a Roth IRA has some penalties associated with taking money out before you hit retirement age. But there are a few notable exceptions that may be useful in an emergency. First, you can always withdraw the money you invested (but not the gains it earned) without paying a penalty.

SIMPLE Individual Retirement Account (IRA)

The SIMPLE IRA is a retirement account available to employees of small businesses. It's an alternative to the 401(k), which is expensive for an employer to manage. It works the same way a 401(k) does, allowing employees to save money automatically through payroll deductions with the option of an employer match.

This amount is capped at 3% of an employee's annual salary. The annual contribution limit for a SIMPLE IRA is $16,000 in 2024. Catch-up contributions of $3,500 allow employees 50 or older to bump that limit up to $19,500 in 2024.

Stages of Retirement Planning

Below are some guidelines for successful retirement planning at different stages of your life.

Young Adulthood (Ages 21–35)

Those embarking on adult life may not have a lot of money free to invest, but they do have time to let investments mature, which is a critical piece of retirement savings. This is the principle of compounding.

Compound interest allows interest to earn interest, and the more time you have, the more interest you will earn. If you can only put aside $50 a month, it will be worth three times more if you invest it at age 25 than if you wait to start investing until age 45, thanks to the joys of compounding.

You might be able to invest more money in the future, but you’ll never be able to make up for that lost time.

Early Midlife (Ages 36–50)

Early midlife tends to bring financial strains, including mortgages, student loans, insurance premiums, and credit card debt.

Still, it’s critical to continue saving at this stage of retirement planning. The combination of earning more money and the time you still have to invest and earn interest makes these years some of the best for aggressive savings.

People at this stage of retirement planning should continue to take advantage of any 401(k) matching programs that their employers offer. They should also try to max out contributions to a 401(k) or Roth IRA (you can have both at the same time). For those ineligible for a Roth IRA, consider a traditional IRA. As with your 401(k), this is funded with pretax dollars, and the assets within it grow tax-deferred.

Some employer-sponsored plans offer a Roth option to set aside after-tax retirement contributions. You are limited to the same annual limit, but there are no income limitations as with a Roth IRA.

Finally, don’t neglect life insurance and disability insurance. You want to ensure that your family can survive financially without pulling from retirement savings should something happen to you.

Later Midlife (Ages 50–65)

As you approach retirement, your investment accounts should become more conservative. Treasury bills (T-bills) are one of the most conservative investments, although their returns are also low compared to other investments.

People in this age group have a few advantages. These often include higher wages as well as more disposable income than younger savers.

It's never too late to set up and contribute to a 401(k) or an IRA. One benefit of this retirement planning stage is catch-up contributions. From age 50 on, you can contribute an additional $1,000 a year to your traditional or Roth IRA and an additional $7,500 a year to your 401(k) in 2024.

Other Investments

Those who have maxed out their tax-incentivized retirement savings options can consider other forms of investment to supplement your retirement savings. Certificates of deposit (CDs), blue-chip stocks, or real estate investments (like a vacation home that you rent out) can be reasonably safe ways to add to your nest egg.

You can also begin to get a sense of what your Social Security benefits will be and at what age it makes sense to start taking them. Eligibility for early benefits starts at age 62, but the retirement age for full benefits is 66.

This is the time to look into long-term care insurance, which will help cover the costs of a nursing home or home care should you need it in your advanced years. If you don't properly plan for health-related expenses, especially unexpected ones, they can decimate your savings.

Other Aspects of Retirement Planning

Retirement planning includes a lot more than simply how much you will save and how much you need. It takes into account your complete financial picture.

Your Home

For most Americans, the single biggest asset they own is their home. How does that fit into your retirement plan?

A home was considered an asset in the past, but since the housing market crash, planners see it as less of an asset than they once did. With the popularity of home equity loans and home equity lines of credit (HELOCs), many homeowners are entering retirement in mortgage debt instead of well above water.

Once you retire, there’s also the question of whether you should sell your home and downsize. If you still live in the home where you raised a family, it might be bigger and costlier than you need or want.

Your retirement plan should include an unbiased look at your home and what to do with it.

Estate Planning

Your estate plan addresses what happens to your assets after you die. It should include a will that lays out your plans.

But even before that, you should set up a trust or use some other strategy to keep as much of it as possible shielded from estate taxes. 

As of 2024, the first $13.61 million of an estate is exempt from estate taxes (up from $12.92 million for 2023), but many people are finding ways to leave their money to their children in a way that doesn’t pay them in a lump sum.

There may also be changes coming down the pipeline in Congress regarding estate taxes, as the estate tax amount is scheduled to drop to $5 million in 2026.

Tax Efficiency

Once you reach retirement age and begin taking distributions, taxes become a bigger problem. Most of your retirement accounts are taxed as ordinary income tax.

That’s one good argument for considering a Roth IRA or a Roth 401(k), as both allow you to pay taxes upfront rather than upon withdrawal.

If you believe you will have a higher taxable income later in life, it may make sense to do a Roth conversion. An accountant or financial planner can help you work through such tax considerations.

Medical Insurance

Medical expenses tend to increase with age. You will have government-sponsored Medicare coverage at a modest cost to you, but many supplement its coverage with a Medicare Advantage or Medigap policy.

Your choices are many and complex. It's a good idea to start checking out your options well in advance of retiring.

The Bottom Line

Everyone dreams of the day they can finally say goodbye to the workforce. But doing so costs money. That's where retirement planning comes into play.

It doesn't matter at what point you are in your life. Setting aside money now means you'll have less to worry about later.