A comfortable retirement requires planning.
If you are just beginning to plan your retirement, then the most important thing to remember is that when you retire, your monthly expenses will continue on.
Therefore, it is essential to ensure that you not only have a comfortable nest egg, but that you plan a logical distribution for your retirement income plan.
Here are two of the main considerations to take when planning how much money you will need to retire.
How Much Money Will You Need?
By the age of 40, you should have set up a retirement fund and you should be focusing on maximizing your monthly allotment to that fund. But how much will you ultimately need? This number will be different for everyone.
It is good to begin by planning for a number which will cover your monthly expenses. A good way to plan for this number is to take the average life expectancy (78 years old) and subtract that from your expected retirement age. If you plan to retire at 65, that will leave you with 13 years to plan for.
Now take your current monthly expenses and multiply that by 156 (the number of months in a 13-year period). Let us say your monthly expenses are $1000 per month. That means you will require $156,000 just to get through your normal monthly expenses.
It will also be necessary to add additional expenses to this base number of $156,000. Two main additions will be medical expenses and vacation expenses.
Medical expenses will be different for everyone. Some people have health insurance while others do not. Some people have preexisting conditions while others are perfectly healthy. For the purposes of this article, let us say you decide on $500 per month for medical expenses. This could be the number which covers your monthly insurance plan or just an amount you have put away for a cash allotment reserved for medical emergencies. Assuming the $500 monthly cost, then you will multiply the original estimate of 156 months by 500 which adds an additional $78,000 to the original number of $156,000, pushing the total thus far to $234,000.
Vacation expenses will be up to you. Some people are content to spend their days fishing, playing golf or gardening locally, while others will prefer to spend their retirement years travelling around the World. For this article, we will put assume an annual allotment at $5,000 per year for vacations. We take the estimated 13 years and multiply that number by $5,000 which adds an additional $65,000 to the total putting us at exactly $299,000.
There will be other factors which will be different for each individual. Do you have a spouse or dependents you need to provide for? Do you want to plan for beyond the average life expectancy? There are countless variables. Give it some thought and come up with a realistic and obtainable total amount you will need to secure your retirement.
Where Should You Keep My Money Until Retirement?
The tried and trusted plan which countless Americans follow on saving for retirement is to secure a retirement plan such as an IRA (Individual Retirement Account) or a 401K at an early age, while still working.
The average American will then continue to contribute to that retirement plan until they reach the age of 59 ½. At that point, the funds in your plan become fully accessible (without penalty for early withdrawal) and eligible to be withdrawn or rolled over into another investment.
There are many options for you once your retirement plan funds become available to you, from putting the money into the stock market or rolling the plan over into a monthly-income-generating investment such as an annuity.
A. CHOOSING THE RIGHT RETIREMENT PLAN
IRAs are retirement investments that you usually set up yourself, while 401ks are usually offered by employers. Both are advantageous for many reasons including offering tax-free growth. The 401K is often more advantageous if your employer matches your contributions, essentially allowing for double the growth. However, 401ks might have a limited amount of investment choices while you will have more control over what your IRA invests into. Most IRAs and 401ks do not allow withdrawals before the owner reaches 59 ½.
The younger you are when you set up your initial retirement plan, the more time your money has to grow. Starting to save early and contributing consistently is essential to preparing for retirement and allowing your investment to grow.
Retirement plans such as IRAs and 401Ks have many advantages. You can contribute as much or as little as you want to them. Retirement plans allow you to earn compound interest (interest earned on both the principal amount and the accumulated interest). You can also secure certain tax advantages by utilizing a retirement plan, as contributions to traditional 401ks are taken directly out of your paycheck before federal taxes are withheld. As those contributions are pre-tax, it lowers your total taxable income, resulting in you paying less in income taxes at tax time. The pre-tax contributions are tax-deferred until you choose to withdraw them in retirement.
Retirement plans such as IRAs and 401Ks have many advantages.
Retirement plans such as IRAs and 401Ks have many advantages. You can contribute as much or as little as you want to them. Retirement plans allow you to earn compound interest (interest earned on both the principal amount and the accumulated interest). You can also secure certain tax advantages by utilizing a retirement plan, as contributions to traditional 401ks are taken directly out of your paycheck before federal taxes are withheld. As those contributions are pre-tax, it lowers your total taxable income, resulting in you paying less in income taxes at tax time. The pre-tax contributions are tax-deferred until you choose to withdraw them in retirement.
B. CHOOSING THE RIGHT INCOME-GENERATING INVESTMENT
Once you have reached 59 ½, it is time to begin shopping for an annuity. Annuities are essentially retirement financial tools. They are retirement investments, but rather than investing your money with banks or traditional investment companies, most annuities are sold by insurance companies.
Generally, most retirees will contribute a lump sum payment to the insurance company to set up the annuity. The funds can be added directly from a regular savings account, or if you had a retirement plan in place already, by rolling over the sum of your retirement plan into a newly formed annuity.
Once you have set up the annuity and depending on the type of annuity you choose (deferred, fixed, immediate, indexed or variable), the insurance company will usually invest those funds and offer you an annual rate of return on your investment. This can be a fixed rate of return or a variable rate of return. The annuity will continue to be invested until the time comes that you decide to retire. At that point, most retirees will “annuitize” the annuity, which means you begin to receive guaranteed monthly income for the remaining term of the annuity (either a fixed set of years or a lifetime annuity), with funds drawn directly from the annuity. The monthly amount you receive is usually decided upon signing the contract.
Annuities have many advantages but is important to find the right one for your specific situation. Many factors come into play when choosing an annuity. The first is the amount of risk you are willing to take. For those not willing to risk their retirement on less predictable investments, a fixed annuity is often the best bet. A fixed annuity guarantees that you will earn a certain amount of interest (usually less than you could earn in the stock market or with mutual funds) and offers a guaranteed payout. For those willing to gamble with additional risk for a potentially larger return, the variable annuity may be the best bet. The variable annuity allows you to choose a risk level you are comfortable with and offers different investment options based on that risk level. Finally, the indexed annuity earns a return tied to a market index such as the S&P 500. The indexed annuity allows you to obtain some of the advantages of both the variable and the fixed annuity. If the indexed fund your annuity is tied to does well, your rate of return/monthly payout could be higher, while if the indexed fund falters, there is still usually a floor (a guaranteed rate of return/monthly payout), thus decreasing the potential for losses.
Choosing fixed, indexed or variable annuities is only the first step. Various annuities start paying out guaranteed income at different times. Some may be set up as immediate annuities which start paying you back within a year after purchase, while others may be set up as deferred annuities which start paying you back at a later point specified in your contract.
Additionally, there are multiple insurance companies to choose from, each offering countless options at differing rates of return. Much like buying other types of insurance, it is important to compare annuity rates before deciding on a product.
While rate comparisons are important, there are other factors to consider as well. The reliability of the insurance company is equally important. It is generally advisable to review the company’s financial rating with A.M. Best, Standard & Poor’s or another financial rating firm. Finding a highly rated insurance company which has longevity, but young upstart companies often have more modern and attractive products. Understand their rating and financial history before selecting a provider.
The product offering the highest rate of return may not always be the right product for you.
The product offering the highest rate of return may not always be the right product for you. Annuities come with multiple add-ons such as annuity riders (a provision you can add to your annuity contract to ensure it meets your financial needs), beneficiary or death options, long-term health care options, funeral coverage, guaranteed lifetime income, commuted payouts, cost-of-living riders, and return of premium riders, to name a few.
While attempting to understand all of these options can be overwhelming, putting in the time and research can be the difference between a good retirement and a bad retirement. Ultimately, the most important factor to consider when shopping for an annuity is that it is crucial that you understand every detail of what you are signing up for.
Retirement plans and annuities are great options for ensuring your money does not outlive you
