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When you think of your future retirement, what comes to mind?
Do you envision spending your golden years in a quiet house by the seaside, taking long walks by the water? Do you picture lots of time spent with family? Are you hoping to devote your time to hobbies like volunteering or travel?
Everyone has their own retirement hopes and dreams, but one thing is for sure — you will need financial resources to draw upon. Once you leave the workforce for good, your regular paycheck goes away.
Instead, you'll rely on a combination of savings, Social Security, and other resources to see you through the following decades.
Ensuring you have adequate funds is critical for a stress-free retirement, but it can be challenging to know where to start.
Whether you're in your 40s or just a few years away from saying goodbye to the office for good, you can benefit from our comprehensive guide to comfortable retirement strategies.
Next Steps: Falling portfolio values can be stressful. We recommend speaking with a financial advisor. This tool will connect you with a fiduciary financial advisor at Covenant Wealth Advisors with over 15 years of experience.
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Determine Your Retirement Financial Goals
Retirement lifestyle planning begins by identifying how much money you'll need to support yourself once you stop working. Start by considering your SMART retirement goals and basic needs, such as housing, food, clothing, transportation, and medical care. Later, you can tack on additional discretionary expenses, such as travel and entertainment.
If you have a mortgage, determine whether you can pay it off before retiring or whether you'll still need to make payments on it for a few years. If you can eliminate your mortgage debt, you can free up hundreds or thousands of dollars each month for other expenses.
Not everyone owns their own home — some prefer to rent, avoiding the long-term commitment of a mortgage and providing greater flexibility. However, if you plan to continue renting in your golden years, keep in mind that rental prices aren't set in stone. Inflation and market demand influence rental rates, and housing costs can increase significantly compared to what you're paying now, especially if you're several decades away from retiring.
Grocery costs are another major expense, but they can go up or down depending on your household size and other factors. For example, if you have young kids at home, you're responsible for ensuring they have food on the table. However, they'll likely be self-sufficient adults by the time you retire, and your food expenses will decrease. Transportation costs may also impact your retirement.
While you won't need to worry about your daily commute to the office, you will still have errands to run, such as shopping and doctor's appointments. Ideally, you'll have a paid-off vehicle you can use. However, you'll still need to pay for car insurance, repairs, and gas. Be sure to plan for the purchase of a new vehicle or two depending upon how long you tend to hold onto cars.
Another significant retirement expense is medical costs. Once you reach age 65, you can enroll in Medicare. While hospital coverage is typically free for most enrollees, you must make monthly premiums to obtain other benefits, including basic medical care and prescription drug coverage. Some retirees may find they eventually need long-term care, which can be unpredictable.
If you retire in your 50s or early 60s, you'll want to plan for private insurance and out of pocket costs which can be expensive!
Finally, consider what type of lifestyle you hope to have in retirement. Frequent travel, dining out, and entertainment expenses can all impact the amount you need to retire comfortably. Include those expenses in the goals you set for yourself.
Once you tally all your expenses, you should have an idea of how much you'll spend each year in retirement. However, keep in mind that you can't predict inflation rates and price changes, so what you pay in the future may be quite different from today's dollars.
Take a look at this graph, which compares annual spending by categories, along with the average annual inflation rate over time:
Source: J.P. Morgan Asset Management
A good rule of thumb is to save at least 25 times your cost of living needs being sure to exclude expenses that will be covered by social security or other sources of guaranteed income.
For instance, if you plan on spending $100,000 per year, and you receive $30,000 per year in social security, you would aim for $70,000 x 25 = $1,750,000 in retirement savings.
That's a very rough estimate, and your personal circumstances can increase or decrease the amount you need, so consider your expectations carefully.
Establish Your Retirement Savings Strategies
Saving for retirement should be a line on your monthly budget, like your mortgage payment or electricity bill. Remember that you're the eventual beneficiary of your retirement savings, so treat it with the importance it's due.
If you don't yet have a monthly spending plan, create one. Determine what your monthly income is and how much you pay for your expenses. Ideally, you'll have some money left over each month for your retirement savings.
While you should commit a regular portion of your monthly income to retirement, you may find it harder to accomplish at specific points in your life. For instance, if you have young children, you may need to cover daycare expenses, which go away as your kids grow older. Other significant fluctuating costs include student loans, auto payments, and credit card debts.
The more you can commit to saving each month, the quicker you will reach your retirement goals. Starting early while you're in your 20s makes it easier to achieve your objectives since your money will have a long time to grow. However, even if you're beginning in your 40s or 50s, it's still completely doable — you'll just need to earmark more cash toward your retirement savings.
Once you determine how much you can allocate toward your retirement savings every month, make an effort to stick with it. You can always increase it as your wages grow or your monthly expenses decline.
As a general rule of thumb, consider saving 15% or more of your earnings toward retirment. You may need to save more if you are starting late.
Consider Your Investment Account Options for Retirement
Several investment vehicles can help you reach your retirement goals. Most people use a combination of options for retirement planning purposes.
Traditional and Roth IRAs
There are several different IRA investment options, including the traditional IRA and Roth IRA. Both require you to open your own account with a provider, such as Fidelity. Once opened, you can contribute money, which can go toward mutual funds, stocks, bonds, exchange-traded funds (ETFs), or other types of assets.
The primary difference between a traditional IRA and a Roth IRA is their approach to taxes. In a traditional IRA, your contributions can be tax-deductible (if you are within income thresholds). If you qualify, that means that every contribution you make reduces your taxable income for the year up to a maximum amount set by the IRS.
Roth IRA contributions are made after-tax, so you can't deduct them from your annual returns. However, when it comes time to withdraw your money from your Roth IRA, you won't owe any taxes on your withdrawals if doke after age 59 1/2. All your contributions grow tax-free over time. Like traditional IRAs, the IRS limits the amount you can invest yearly. Income limitations also restrict people from investing in a Roth IRA if their earnings exceed a certain amount.
Traditional 401(k)
The 401(k) is the gold standard of employer-administered retirement plans. It allows participants to contribute part of their earnings, usually a percentage amount, toward investment assets such as stocks, bonds, and ETFs. Employers can choose to match their employees' contributions, which can help build the 401(k)s value over time.
The IRS limitations for employee contributions to a 401(k) are $22,500 in 2023, and individuals age 50 or over can contribute an additional $7,500. That's much higher than IRA contribution limits, which are $6,500 for people under 50. However, since you make contributions before tax, you will owe tax on the withdrawals in retirement.
Roth 401(k)
Some employers offer a Roth 401(k), which combines different features of the Roth IRA and the traditional 401(k). Under a Roth 401(k), all your contributions are after-tax, so you won't owe Uncle Sam any money on your withdrawals in retirement age. Your employer can also match your contributions, which can help you grow your retirement savings quickly.
The IRS limits contributions to a Roth 401(k) are the same as traditional 401(k). However, if you have both a Roth 401(k) and a traditional 401(k), the maximum combined contributions to each can't exceed the annual limits.
SIMPLE IRAs
Many small businesses offer their employees SIMPLE IRAs as an alternative to the 401(k). A SIMPLE IRA works similarly to the 401(k) in that it allows employers to supplement their employee's contributions with a match. However, it's typically cheaper and easier to set up than a traditional 401(k).
Employees who participate in a SIMPLE IRA can contribute up to $15,500 in 2023, per the IRS. They can choose between various investment assets, including stocks, bonds, and ETFs. The SIMPLE IRA also allows for catch-up contributions of $3,500 for people aged 50 or older.
Simplified Employee Pension Plans
A Simplified Employee Pension (SEP) plan is ideal for freelancers or self-employed entrepreneurs with one or more employees looking to save for retirement. You must own your own business to open a SEP, and you can contribute up to the lesser of 25% of your compensation, or $66,000 in 2023.
Like IRAs, you can establish a SEP with any financial institution that offers them, including banks and brokerages. However, only employers can contribute to a SEP. If you're not a business owner, you'll rely entirely on the contributions your employer makes for you. You can't make any to the plan yourself.
Other Retirement Income Solutions
Saving for retirement is only one part of the puzzle. You may have income from various other sources, too.
Traditional Pension
In a traditional pension, the onus of saving for retirement flips from the employee to the employer. The employer provides a guaranteed retirement benefit for workers based on their time with the company, average salary, and age. The payout can be monthly, annually, or on a lump-sum basis once the employee reaches their retirement years.
These days, it's uncommon to find companies offering a traditional pension plan. Most organizations offer employees 401(k)s, SIMPLE IRAs, or other defined contribution plans, which are less costly and risky to employers. However, some government employees, such as military and civil service workers, may be eligible for a traditional pension plan.
You're in luck if you have access to a traditional pension plan. You'll receive regular payments during your retirement courtesy of your employer. Depending on your years of service, annual earnings, and other factors, you may find the pension is enough to support you through your retirement, especially when combined with Social Security. However, check with your plan's administrator to understand what you can expect from your future payments.
Annuity Options
Life insurance companies, brokerages, and banks sometimes offer annuities, which can provide a guaranteed income stream for a period of time. Some people purchase annuities to supplement their retirement income and receive the proceeds as monthly, quarterly, annual, or lump-sum payments. In some cases, annuity payments can last the remainder of their lives.
Several forms of annuity options exist, including fixed, variable, and indexed. In a fixed annuity, you receive a specified amount of future payments at a guaranteed interest rate. Variable annuities allow you to select from various investment options, such as mutual funds, which you can use your premium payments to purchase. Your future income from a variable annuity will vary depending on your rate of return and the plan's expenses.
An indexed annuity ties your future payout to a specific stock market index, such as the S&P 500. You'll receive earnings based on it's performance and initial investment amount.
Annuities aren't for everyone, and they have certain advantages and drawbacks. If you want to incorporate them into your retirement planning, it's smart to speak with a financial advisor who can help you determine whether they're an appropriate alternative for your circumstances.
Social Security Benefits
Most American tax payers will qualify for Social Security benefits in their retirement years. Social Security provides recipients with monthly benefit checks at a set amount for the remainder of their lives. The amount you receive depends on your average earnings throughout your lifetime and when you start receiving your benefits.
To qualify for Social Security in retirement, you must earn at least 40 working credits. Each credit equals three months of work, so most people work ten years before they can qualify for benefits. Social Security uses your highest 35 years of earnings to determine the amount of your check, and what you receive will likely only be a portion of your regular pay. Thus, most people don't rely entirely on Social Security to support them in their golden years. Instead, they combine Social Security with retirement savings plans and other alternatives.
A sound retirement plan will provide guidance on how to optimize your social security benefits so you don't leave money on the table.
Continue Working
No rule says you must quit working at age 65 or 67. Whether you worry that you won't have enough money to sustain your remaining years or simply enjoy working and can't picture yourself without a job, full or part-time work is a viable option. It can keep you busy, and the paycheck can supplement your retirement savings, Social Security benefits, and other income sources.
If a full or part-time job isn't appealing, you can look at passive income opportunities. For instance, you might consider buying and renting a property or investing in a local business that needs your cash. Both options can provide steady earnings without committing to a regular weekly workload.
Downsizing
Another way to free up income for retirement is downsizing. To do so, look at your current living situation and see where you could cut costs that eat into your retirement income sources.
Start with your home. Are you living in a large house with multiple bedrooms you no longer need? Is the house paid off, or do you have several more years of mortgage payments? You can consider selling your home and using the proceeds to buy something much smaller, such as a one or two-bedroom condo. Shifting to a smaller home can reduce your monthly mortgage, electricity bills, and property insurance costs.
Another downsizing option is moving to a cheaper area. If you're no longer dependent on your location because of a job, young children, or other reasons, you can move somewhere with a lower cost of living. For instance, a move from New York City to a small town in Tennessee could cut your living expenses significantly, freeing up more money for a comfortable retirement.
Don't Overlook Long-Term Care Planning
The prospect of needing long-term care may not concern you when you're young or healthy (or both), but life can change on a dime. As you age, your risk of developing health conditions requiring long-term care rises. The Administration for Community Living (ACL) estimates that nearly 70% of people age 65 or older will need some form of future long-term care.
Unfortunately, Medicare doesn't cover the costs of long-term care, even if you buy additional Medicare coverage, such as Medigap. Instead, you must foot the bill yourself or rely on your loved ones to pay for it. Some people may qualify for free long-term care through Medicaid, but only if they meet stringent financial requirements.
You can protect yourself from draining your retirement savings for long-term care costs with an insurance policy. Various insurance companies offer long-term care policies, which provide coverage benefits if you become unable to perform basic living activities, such as bathing or getting dressed. Your policy will cover the cost of nursing homes, assisted living facilities, or in-home care.
Next Steps: Falling portfolio values can be stressful. We recommend speaking with a financial advisor. This tool will connect you with a fiduciary financial advisor at Covenant Wealth Advisors with over 15 years of experience.
Here's how it works:
Answer these few easy questions, so we can understand your situation.
Schedule a call with a credentialed financial advisor who can help you on the path toward achieving your financial goals. It only takes a few minutes.
Check out the advisors' profile and have an introductory call on the phone or introduction in person, and choose who to work with in the future.
There are two types of long-term care insurance policies: traditional and hybrid. A traditional policy provides long-term care benefits, but you may lose all the premiums you pay if you never need them. Some companies offer options you can add to the policy, such as a return of premiums if you never use it for an additional fee.
A hybrid long-term care policy combines life insurance or annuities with your long-term care benefits. Under a hybrid policy, you may be able to access your funds during your lifetime, helping to supplement your retirement income. If you opt to include life insurance, your survivors will receive the death benefits from your policy once you die, assuming you never need long-term care.
Long-term care insurance providers offer different levels of coverage and benefits, and premiums will vary depending on when you purchase your policy and your current health status. You can minimize costs by buying a plan early, such as in your late 40s or 50s, rather than waiting until you're already retired.
Incorporate Tax-Efficient Retirement Planning to Minimize Your Future Liabilities
Unfortunately, taxes don't entirely disappear once you retire. Even if you don't work, you'll likely owe taxes on some sources of retirement income, including Social Security benefits. The key to minimizing your future liabilities is understanding where your income sources will come from, which will help determine your tax bracket. Other factors, like the state you live in, can also impact your taxes.
Three primary elements can impact your future retirement tax liabilities. Let's take a look at each.
When You Begin Receiving Social Security Benefits
Source: J.P. Morgan Asset Management
Your Social Security benefits will likely be a significant component of your retirement income. Currently, you can begin receiving your Social Security benefits at age 62, though you'll only receive a portion of the benefit. Waiting until you reach full retirement age entitles you to 100% of your benefits. Delaying retirement even longer provides you with additional benefit increases each month until you reach age 70.
Social Security benefits are partially taxable at the federal level, and some states tax them, too. If you start drawing Social Security while still earning a regular paycheck, your tax bracket will be higher, forcing you to pay more than you would if you no longer had a job.
To minimize your tax liabilities (and maximize your future Social Security benefits), you can delay collecting Social Security until you reach full retirement age or even longer. During that time, you can continue to work or rely on other sources, such as an IRA or 401(k), to fund your retirement. Depending on your retirement savings plan, you may not need to pay taxes on your withdrawals.
Let's consider a hypothetical example of Janet, a single female earning a $100,000 salary at 62. She is in good health, has no existing medical conditions, and doesn't feel ready to retire. She delays collecting Social Security so she can increase her benefit amount. At 67, she's still relatively healthy and continues working until age 69, when she begins collecting benefits. By waiting, Janet increased her Social Security benefits and minimized tax liabilities since she will only owe taxes on income from her job, not a Social Security check, too.
Consider the Tax Implications of Withdrawing Your Retirement Savings Income
All retirement savings plans impact your taxes differently. Traditional IRAs and 401(k)s are tax-deferred, meaning you can deduct your contributions to both plans from your taxable income during your working years. You'll pay taxes on all future withdrawals you make in retirement. That may be advantageous to you if you're in a higher tax bracket in your contribution years. However, your tax liabilities increase if your tax bracket is higher when distributions begin.
You make contributions to a Roth IRA or Roth 401(k) after tax, so you can withdraw money from them tax-free in retirement, assuming you meet a few requirements. If you're in a higher tax bracket than during your earning years, drawing from your Roth accounts first can help minimize your liabilities.
At Covenant Wealth Advisors, we often recommend using a combination of retirement savings vehicles for tax planning purposes. That way, you can decide which one to draw from based on your current tax situation.
Let's look at another hypothetical example of Phillip, who, at age 62, has ten years left on his mortgage. He is still working and in excellent health. Phillip wants to increase his monthly mortgage payments to pay it off before age 67, but he can't afford to do so using only his paycheck.
Instead of applying for his Social Security benefits or withdrawing money from his traditional 401(k), Phillip turns to his Roth IRA. Since he meets the requirements for tax-free withdrawals, he can use them to pay down his mortgage without increasing his taxable income.
Plan for Required Minimum Distributions (RMDs)
Certain tax-advantaged plans, including traditional IRAs and 401(k)s, require you to begin making minimum withdrawals by age 73. The higher your account balances are, the larger your RMDs will be, potentially increasing your tax bracket if you also collect Social Security. You can mitigate your liabilities by spreading your withdrawals across various sources, maximizing retirement income.
As an example, consider Lisa, who retires from her job at 62. She has a traditional 401(k) and a Roth IRA with similar balances. She decides to forego claiming Social Security for a few years to maximize her benefits, so she begins withdrawing funds from her 401(k). She exhausts the balance of her 401(k) by age 70 when she claims Social Security and pays ordinary income tax on the withdrawals.
Lisa's Social Security benefits are taxable, but she can supplement them with withdrawals from her Roth IRA, which aren't. Lisa successfully minimized her retirement tax liabilities by allocating withdrawals at ideal points in time.
Start Estate Planning Early
Your death may be years or decades in the future. However, setting up a solid estate plan now can prevent problems down the road for your heirs.
Estate planning can be quite complex or very simple. It all depends on the value of your assets and whether your beneficiaries will encounter estate taxes when they inherit them. Other factors, such as family dynamics and divorces, can also impact your estate plan.
Speak with an attorney concerning your estate planning needs. They can help you formulate an estate plan that reduces legal friction and minimizes tax liabilities for your heirs. If you die without leaving a will or designating beneficiaries for your assets, including retirement savings accounts, everything could end up in probate court — which can take months or years to resolve.
Retiring Early Is Possible With The Right Strategies
Not everyone plans to retire in their 60s or 70s. Some plan to do so much sooner — such as in their 50s. Consider these early retirement tips if you hope to quit the workforce before the traditional retirement age.
Know Why You Want to Retire Early
Retiring early can allow you to pursue what you enjoy, whatever that might be. Maybe you want to travel, be a full-time parent to your children, volunteer for a cause close to your heart, or write the next great American novel. However, if you don't have a clear reason for retiring, you may have a lot of time you don't know what to do with. Identifying your purpose can help you stay in tune with your goals.
Understand the Financial Repercussions of Retiring Early
Most retirement savings plans won't allow you to make early withdrawals before a certain age. If you decide to tap into them before the age limitation, you'll incur taxes and penalties that can significantly impact your account balances, leaving you with less to rely on in your later years.
Next Steps: Falling portfolio values can be stressful. We recommend speaking with a financial advisor. This tool will connect you with a fiduciary financial advisor at Covenant Wealth Advisors with over 15 years of experience.
Here's how it works:
Answer these few easy questions, so we can understand your situation.
Schedule a call with a credentialed financial advisor who can help you on the path toward achieving your financial goals. It only takes a few minutes.
Check out the advisors' profile and have an introductory call on the phone or introduction in person, and choose who to work with in the future.
To minimize the impact on your retirement plans, use other financial resources to fund yourself. Investing in stocks, bonds, annuities, or real estate are all viable alternatives that don't incur penalties, although you will pay taxes on your gains and earnings.
Pay Off Your Debts
Reducing expenses is key to an early retirement strategy, and debt can quickly derail your plans. Before you retire, plan to pay off all high-interest debts, including credit cards, student loans, and auto loans. If you have a mortgage, consider paying it off, too. The less debt you have dragging you down, the easier managing money in retirement will be.
Set a Spending Budget
Retiring early certainly has its appeal, but keep in mind you will need to rely on your own savings and investments to fund yourself for decades without a paycheck. Thus, you'll want to be sure you can commit to a budget that allows you to live the life you want without setting yourself up for future financial problems if you run out of money but can't work.
Remember that prices can change significantly over time, so the $1,000,000 you have in the bank may be worth much less, even five or ten years down the line. Work with a financial advisor to help establish a monthly budget that will stand the test of time.
Financial Security in Retirement Starts with Preparation
There are many moving pieces when it comes to planning for retirement. Determining how much savings you'll need, where to allocate it, and establishing a budget are just a few considerations. It's a lot to handle on your own, so seeking retirement investment advice from a qualified financial advisor is critical.
At Covenant Wealth Advisors, our team offers fee-only financial planning services that can help you reach your future goals. With our help, you can alleviate the stress of retirement planning and avoid costly mistakes. Contact us today to request a free retirement assessment.
Author: Mark Fonville, CFP®
Mark is a fiduciary, fee-only financial advisor at Covenant Wealth Advisors specializing in helping individuals aged 50 plus plan, invest, and enjoy retirement without the stress of money.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosure: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible but no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice.
Registration of an investment advisor does not imply a certain level of skill or training.