There are a number of different aspects to creating a comprehensive retirement plan that you should consider. Following is a broad overview of five key factors you should think about as you craft your plan.
- What's Your Number?
One traditional rule of thumb is to plan on needing about 70-80 percent of your pre retirement annual income during retirement. However, this is only a general guideline, and everyone's situation is different. If you plan to travel extensively after you retire or help support your children or grandchildren, your expenses in retirement could easily equal or exceed your pre-retirement expenses.
Also, don't forget to factor the effects of inflation into your projections. Even at low levels, inflation erodes the value of your savings and eats into your purchasing power over the long term. For example, the purchasing power of one dollar 20 years ago has shrunk to just 44 cents today–and will shrink to just 19 cents 20 years from now.*
- What Vehicles Will You Use?
There are a number of different savings and investment vehicles that can help you reach your retirement goals. These include:
- Individual Retirement Accounts (IRA s)– There are two primary types of IRAs to choose from, each with its own features and benefits:
- Traditional IRA: The original IRA, now referred to as a traditional IRA, offers tax deferred growth and an immediate tax break in the form of a deduction equal to the amount of your annual contribution if you qualify. (Eligibility for this deduction phases out above certain adjusted gross income limits and may not be available if you participate in an employer-sponsored retirement plan.) Taxes must be paid at your ordinary income tax rate when you begin taking distributions during retirement.
- Roth IRA: The Roth IRA differs from a traditional IRA in two key respects: First, there is no immediate tax deduction for annual contributions. But this is offset by the fact that contributions grow tax-free, instead of just tax-deferred. Qualified withdrawals in retirement are also tax-free. This can make a big difference over the life of the account. Another benefit of Roth IRAs is that contributions (but not earnings) can be withdrawn tax-free and without penalty at any age. In contrast, withdrawals from a traditional IRA before age 59½ are usually subject to a 10 percent early distribution penalty. Keep in mind that eligibility for contributing to a Roth IRA phases out above certain adjusted gross income limits (see Roth vs. Traditional IRA chart below).
Roth vs. Traditional IRA
|Contributions may be tax-deductible1||X|| |
|Earnings grow tax-deferred||X|| |
|Earnings grow tax-free|| ||X|
|Withdrawals can be made tax-free2|| ||X|
|Anyone can contribute3||X|| |
1 In 2010, deductibility for traditional IRA contributions phases out for individuals with modified adjusted gross income (MAGI) between $56,000 and $66,000 and married couples filing jointly with MAGI between $89,000 and $109,000 who are covered by an employer-sponsored retirement plan.
2 Withdrawals of principal from Roth IRAs can be made without tax or penalties at any age. Withdrawals of earnings are tax-free if the Roth IRA has been open for at least five years andthe individual is age 59½ or over, or if the funds will be used for a first-time home purchase (subject to a lifetime limitation of $10,000) or due to death or disability.
3 In 2010, eligibility to make Roth IRA contributions phases out for individuals with MAGI between $105,000 and $119,999 and married couples filing jointly with MAGI between $167,000 and $176,999.
- 401(k) plans–Unlike IRAs, 401(k)s are established by employers for their employees, who can make pre-tax salary deferrals into their accounts, thus reducing their current taxes. Meanwhile, earnings grow without the burden of taxation, since you don't pay taxes until you start taking distributions after retirement.
- 403(b) and 457 plans–These are similar to 401(k) plans, but 403(b) plans are designed specifically for educational and non-profit organizations, while 457 plans are for state and local government entities. The annual contribution limits are the same as 401(k) plans.
- Simplified Employee Pension plans (SEPs) and SIMPLE IRAs–These are designed for small businesses and self-employed individuals. In 2010, you may contribute up to $49,000 to a SEP and $11,500 to a SIMPLE IRA (or $14,000 if you're age 50 or over).
- What's Your Investment Strategy?
When it comes to investing for a long-term goal like retirement, experts agree that the best way to increase your chances of success is to diversify your investments across a wide variety of different types of assets and asset classes.
- What About Your Health Care Costs?
One study by the Employee Benefit Research Institute concluded that a 65-year-old couple who lives to average life expectancy (approximately 82 for the husband and 85 for the wife) could need as much as $295,000 for health insurance premiums and out-of-pocket expenses during retirement**. This amount rises to $550,000 if they live to age 95. Medicare covers only about one-half of retiree medical expenses, the study noted.
A supplemental MediGap policy purchased through a private insurer will cover some of the holes that exist in Medicare coverage. In addition, you may have the option of purchasing retiree health insurance from your or your spouse's employer. Finally, you might consider buying long-term care insurance before you retire.
- What Will You Do in Retirement?
If you're planning to stop working at the traditional age of 65, you could easily spend 25 to 30 years or longer in retirement &ndash that's a lot of golf and traveling! That's why nearly eight out of 10 baby boomers in a recent AARP survey said they expect to work at least part-time after they retire.
*Based on an annual inflation rate of 4.2%
**Source: Employee Benefit Research Institute, "Issue Brief," July 2006
†Source: Investment Company Institute (ICI)