Do you know what your target retirement age will be? Have you assessed what your costs will be post-retirement? Have you thought about your healthcare costs and how you will cover them once you have transitioned off of an employer healthcare plan? If you have, you’ll have a firm understanding of how important retirement planning is. If you haven’t, it’s time to take a hard look at what your long-term financial plans are.
The reality is that many people fail to adequately plan a retirement fund. Retirement is an important time in your life where you are able to enjoy the benefits accrued from years of hard work. However, in order to do so, you must plan ahead during your prime earning years. Today, far fewer individuals retire with a pension, while an increasing number of retirees rely on social security and their 401k.
In this article, we’ll look at some of the most important factors you should consider when deciding how early to start planning for retirement. There are a number of considerations you should weigh, including your projected healthcare costs, whether you will be fully vested in social security and when to begin drawing benefits, and whether you will be using a defined contribution plan or defined benefit plan to fund your retirement. The truth is that it is never too early to start saving for retirement. Beginning your retirement planning early will give you greater flexibility in how much you save and how you invest your portfolio.
Most People Don’t Adequately Plan for Retirement
If you haven’t considered planning for retirement yet, you aren’t alone. According to a recent survey, 21% of Americans don’t have any retirement savings at all. 10% only have $5,000 or less. If this isn’t surprising enough, according to the same survey, the average retirement savings for all Americans is only slightly more than $84,000. Other surveys put the average retirement savings around the same level.
What these surveys suggest is that far too many people fail to adequately plan for retirement. Even for those Americans that are saving, most aren’t saving enough. How much you need to save for retirement will depend on a number of factors. These include whether you have other passive income streams, if you will be fully vested in social security, what the health of your retirement portfolio looks like, and what your projected healthcare costs will be during retirement. On top of this, factors such as paying for your children’s college tuition will have an impact on your post-retirement costs. You will also want to consider what you want your post-retirement quality of life to be. If it closely tracks your lifestyle before retirement, you’ll have to factor that into your calculations.
Post-Retirement Healthcare Costs
You might be wondering, “why is financial planning for retirement vitally important?” It may seem like a problem you can tackle at some point in the future. Or, you might be thinking that social security will cover your costs. One factor you should consider is your post-retirement healthcare costs. Even if you downsize and maintain a modest lifestyle after retirement, you will still have to grapple with healthcare costs.
Planning for your healthcare costs post-retirement is complex, and reinforces the need to work with a skilled financial planner. Retirement is the time where most people transition off of an employer-sponsored healthcare plan and onto Medicare or Medicaid. Understanding how healthcare costs are allocated under Medicare and Medicaid is important so that you can get a better understanding of what your long-term healthcare costs will be.
Even if you are planning on retiring soon, it isn’t too late to begin saving for your post-retirement healthcare costs. Not only will the transition to Medicare of Medicaid affect your healthcare costs, but consider the fact that healthcare costs are steadily rising each year. According to the Centers for Medicare & Medicaid Services (CMS), healthcare costs are projected to rise 5.5% per year through 2026 with a larger rise of almost 8% for Medicare spending.
While healthcare costs are on the rise each year, people are also living longer. This means you’ll not only need to save more for your retirement, but you’ll have to account for how a longer lifespan will impact your healthcare costs. This can be difficult, and ultimately will never be exact. However, you can take strides to ensure that you are adequately prepared for any eventuality. If you begin saving for your post-retirement healthcare costs early you will most likely be able to set aside much less of your income. Even if you are nearing retirement but have a healthy retirement portfolio, you may want to create a healthcare savings plan for your post-retirement years.
A central component of many retirement plans is social security. When you are planning for retirement, you will want to have an understanding of when you are fully vested in social security and what age you will begin drawing social security benefits. The answers to these questions will help determine the health of your overall retirement portfolio, while it will also inform the rate at which you will need to save using other retirement vehicles.
A financial advisor can help guide you through how to best utilize your social security to achieve your post-retirement goals. If possible, you’ll want to avoid drawing on your social security before you have reached your Full Retirement Age (FRA). If you draw on your social security benefits while you are still working, the amount you receive will be reduced in relation to your income revenue. However, this doesn’t count income generated through annuities, pensions, or other common retirement revenue streams.
In order to ensure you maximize your social security benefits, you will want to start working with a financial planner. Your financial planner can help you get a better understanding of how your social security benefits will interact with the rest of your retirement portfolio, and break down the advantages and disadvantages of when to begin withdrawing social security benefits. Getting a full understanding of your options when it comes to social security is why retirement planning is important to begin early. Given enough time, you can make smart financial decisions that create the foundation for other sources of retirement income that allows you to maximize how you use your social security benefits.
Pension vs. 401(k)
There are two broad categories of retirement plans; defined contribution plans and defined benefit plans. Defined contribution plans are the most common type of retirement vehicle that is now found in the private sector, and includes the familiar 401(k), 403(b), employee stock options, and profit sharing plans. Over time, the use of these types of retirement vehicles has eclipsed that of defined benefit plans. A defined benefit plan commonly referred to as a pension, is far rarer today than it was in the past, particularly in the private sector.
Understanding the differences between a pension and a 401(k) or other defined contribution plan is essential for maximizing your post-retirement income. If you are eligible to receive a pension when you retire, a financial planner can help you maximize the utility of that pension benefit over the course of your retirement. At the same time, it is important to understand how defined contribution plans work because this can have a large impact on how you approach retirement saving. If you are asking yourself, “why is retirement planning important today” and you have a defined contribution plan, then you should strongly consider working with a financial planner as soon as possible.
The core difference between a defined contribution plan and a defined benefit plan is simple. A defined benefit plan gives the retiree a static benefit for the remainder of their life after they retire. Defined benefit plans are typically offered for public sector employees, with only 5% of private sector employees still eligible for a pension plan. A pension plan is generally tied to your years of service and provides a defined benefit to the retiree until their death.
In contrast to a defined benefit plan, a defined contribution plan such as a 401(k) requires the employee to contribute to their plan throughout their years of working. Contribution plans generally offer some tax advantages to the contributor, such as reducing your level of taxable income. At the same time, defined contribution plans give the employee greater control over how they invest their retirement portfolio. A second added advantage of defined contribution plans is that they provide the employee with a greater degree of portability between employers, while a defined benefit plan is tied directly to a specific employer such as the federal government or municipal government.
Retirement planning will help you ensure that you are maximizing your benefits in retirement. This is true whether you are planning on receiving benefits from a defined contribution plan or a defined benefit plan. Planning early is essential with defined contribution plans to ensure that your retirement portfolio is healthy and adequate for your projected post-retirement costs. A financial planner will give you a clear idea of if your retirement savings is adequate for your needs. If it isn’t, they can help you create a budget for your money that will enable you to achieve your long-term financial goals
If you have a defined benefit plan, a financial planner can help you determine the type of annuity option that will be most beneficial for your specific circumstances. In some cases, it may be ideal to take your pension plan as a lump-sum payment. One of the disadvantages of a defined benefit plan is that because of inflation your defined benefit becomes less valuable over time, resulting in steadily decreasing payments at a point in your life where healthcare costs are rising. Taking your defined retirement benefit as a lump-sum payment and investing it according to guidance from your financial planner can be a way to outpace inflation, resulting in a higher benefit over time.
Retirement Planning is Vital
Many people fail to adequately plan for their retirement, leading to financial hardship, a decreased standard of living, or a return to the workforce in part-time employment once they hit retirement. Avoiding this outcome requires having a firm understanding of what your retirement portfolio looks like and if it is adequate to cover your projected expenses. Don’t underestimate your expenses during retirement. Things like healthcare costs are rising every year. Alongside this, people are living longer, which not only results in higher ongoing healthcare costs but can also result in outliving your retirement.
Adequately planning for retirement often requires starting early. However, even if you are nearing retirement, it isn’t too late to make targeted financial decisions that can allow you to achieve your financial goals with a little bit of work. Retirement income planning allows you to secure your financial future through careful stewardship of your retirement portfolio and maximizing the benefits you will receive. If you are entering your prime earning years, you will want to work with a financial advisor to ensure that your retirement goals are realistic and achievable, then craft a budget that allows you to realize your goals. Be sure to talk to several reliable companies before choosing your financial advisor for your retirement planning.
It is never too early to begin planning for your retirement. Working towards your retirement goals over time will allow you to maximize your retirement portfolio, while also minimizing the impact that saving for retirement can have on your quality of life now. Additionally, a financial advisor can help place your retirement plan in the context of your other goals, such as saving for your children’s college tuition or real estate investments. By creating a comprehensive financial plan that includes retirement, you will be able to ensure that your long-term financial goals are clearly defined and achievable. For more information on retirement planning financial services, contact Bull Oak Capital today.