So if you want to have a comfortable life in your golden years, you need to start preparing for retirement now. Here are three steps to get started:
- Understand your time horizon
Know how long you have till retirement. This is based on two things: your current age and the age at which you want to retire.
So if you’re 30 years old now, and you want to retire when you’re 60, you have a time horizon of 30 years (60 – 30 = 30).
This is important information because it helps you know what investing strategy to have.
If your time horizon is 30 years, you can afford to take on more risk with investments like stocks to grow your retirement savings. Stocks are volatile in the short term, but over the long term (10 years or more), they yield average returns of 10%.
If your time horizon is under 10 years, you’ll want to take on less risk and focus on preserving capital. Most people do this by moving their retirement savings from stocks to bonds.
Bonds offer smaller returns (between 5% and 6%) but they’re also less volatile, which means you don’t need to worry as much about their value dropping.
- Determine your retirement spending needs
Once you know how much time you have until retirement, determine your retirement spending needs.
To live comfortably in retirement, you should plan to have 80% of your preretirement income. So if you make $100,000 now, you should plan to have an income of $80,000 after you retire.
However, it’s important to set realistic spending expectations. After all, you don’t want to run out of money.
For example, you might have unforeseen medical expenses come up or need to join a retirement home with skilled nurses if you’re one day unable to take care of yourself.
Maybe you’ll still have a mortgage to pay off or need to fund a child’s college education. Or maybe you’ll spend more on vacations because you’ll have more time to travel. All of this must be taken into account.
The more you specify your retirement spending needs, the better you can prepare for them.
- Contribute regularly to a retirement account
Lastly, start contributing to a retirement account now. Assess your risk tolerance and figure out what rate of return you need to reach your retirement goals.
Most people invest through an individual retirement account (IRA) or a 401(k). Both help you save for retirement and offer tax benefits.
Traditional IRAs allow you defer paying taxes on your contributions until you withdraw at retirement, and Roth IRAs allow you to invest after-tax dollars and then withdraw them tax-free once you retire. Both types of IRAs allow you to contribute up to $6,000 per year.
401(k)s are retirement accounts offered by your employer. Contributions are taken directly out of your paycheck before income taxes are deducted, which reduces your tax bill. You can contribute $20,500 per year (or $27,000 if you’re 50 or older).
Plus, many companies match 401(k) contributions up to a certain limit. So you might as well contribute as much as they’ll match. It’s free money!
If you don’t have a lot of money to put toward your retirement right now, start small. Even $50 per month can go a long way, especially when you start early. Set up automatic withdrawals to make it easier to save.
Then don’t touch your retirement account until you retire (at least 59.5 years old). If you do, you’ll not only incur early withdrawal penalties, but it’ll defeat the point of saving.
If you switch jobs and need to change retirement accounts, that’s okay. You can roll over retirement funds with no penalty.
Taking control of your retirement plan is more important today than ever. That’s because few companies offer pensions anymore and you can’t rely on Social Security to fund your retirement either.
So start today. The sooner you do, the more you’ll benefit from compound interest. Get help from a professional financial advisor if you need it.