Oftentimes the focus when planning for retirement is on finding the dollar amount you need to retire comfortably and meet your financial goals. With proper planning, you can achieve financial freedom and enjoy retirement.
Here are five simple steps to make sure you can reach your retirement goals.
Understand your income
Retirement looks different for everyone, so when creating a financial plan you should always review factors that contribute to your ability to achieve the lifestyle you want. You can’t know how much to save for retirement if you don’t know how much you’ll want or need to spend. A general rule is to plan for between 60–80% of your current income to maintain your lifestyle in retirement.
The first step is to understand your current income to create a foundation for a financial plan for retirement. Your current income defines your existing standard of living and can be used to project future earnings to determine what you’ll spend in retirement.
Hitting goals early allows you to have diversified streams of income, which can elevate your savings and interest rates, which can compound quicker for you.
Diversify accounts and investments
Once you have a better understanding of your income and how it supports your lifestyle, you’ll have the information needed to make some decisions. Diversifying your investments is a common practice to help achieve a portfolio that is more stable in a variety of economic environments. Likewise, it allows you to be more tactical with your savings, so you have more flexibility when making withdrawals throughout retirement.
A secure retirement is a major concern in the U.S., and the surefire way to properly diversify your accounts is to save in a variety of investment vehicles like a 401(k), Traditional and Roth IRAs, HSAs, 529s, and taxable brokerage accounts.
It’s important to make sure you take advantage of any savings accounts available to you that may have incentives, tax advantages, or matching dollars. Typically, we recommend saving at least the amount your employer matches and then allocating dollars to other accounts from there based on your goals.
After you have a strategy on where to allocate your dollars, it’s time to determine how you are going to achieve the growth required to meet your goals. Taking a diversified approach to investing can match your appetite for risk with the timeframe of your investment objectives. This affords you the ability to tailor your portfolio to support your financial goals and identify any changes needed to attain them.
Avoid lifestyle creep
Lifestyle creep, also known as lifestyle inflation, is when you receive income increases like a raise at work and your living costs or lifestyle increases by the amount of any increase in wages. Over time, inflation actively works against you and your retirement plans.
It affects your retirement income by increasing the future costs of goods and services, which reduces the purchasing power of every dollar you spend. So, on average every $1 you spend this year will require you to spend $1.02 - $1.03 next year for the same purchase.
It is important to structure your accounts so your savings grow by more than inflation on an annual basis. This will protect your purchasing power until and throughout retirement. Even a low inflation rate can still have a significant impact on your money.
This creep can also contribute to increasing annual spending. It happens gradually over extended periods of time, which makes it hard for people to notice. This can be dangerous and it’s a major reason why retirement plans get delayed or the amount needed to retire grows substantially.
A good approach to avoid lifestyle creep is to save 50% of any raise you may receive. This keeps your spending in check and your savings rate elevated so you have more flexibility in the future. It’s all about balance, which enables you to live how you want to live now without a substantial change when you get to retirement. The larger the spending cut you must take in retirement, the more likely you are to run out of money.
Create a tax strategy
In addition to inflation and lifestyle creep, taxes also play a role in negatively affecting your retirement plan. Each component we’ve discussed so far can be tied back to your taxes and is a piece to consider when making decisions. From the accounts you choose, to the investments you make, to the age you decide to retire, everything has tax consequences.
Ideally the planning decisions you make provide flexibility and control when executing your retirement plan. If you want to pay cash for your dream car or buy a second home, you want to be able to do so without a large tax bill as a result. Planning for taxes ahead of time is just another way to increase your chances of successfully meeting your financial goals.
Plan for health care costs
Managing your health care costs is an important part of your retirement planning. Today people have longer life spans and medical costs are rising faster than general inflation. This means that you should have a strategy to account for these factors in your retirement planning.
Without thoughtful planning, you could end up outgrowing your savings and have to rely solely on Social Security. A common planning tactic is using an HSA to cover medical costs later in life. An HSA is the only triple tax advantage account available, meaning you deposit money tax free, it grows tax free and your withdrawals are tax free when used for qualified medical expenses including long-term care.
If you can afford paying medical expenses without using your HSA dollars when you are younger, then do it. The HSA can be the most powerful savings account when invested for growth and used later in life for medical expenses.
After focusing on accumulation and growth and investing for many years, switching to a longevity risk period and spending money can be stressful and unpredictable. There will always be things we can’t control when planning for retirement, like the economic cycle or unforeseen health issues.
Proper planning and the steps you start taking now can help remove uncertainty and get you on track to achieve your retirement goals. Using these steps can help you manage and secure your retirement income.