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Budgeting for the Future—How Much Money Will You Need?
Sources of Retirement Income
Other Retirement Issues
Deciding When to Retire
Setting Financial Gains
The Time to Start Planning Is Today
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This discussion provides a broad general overview of the complex issues in planning for a comfortable retirement and is not intended to provide you with specific advice. Everyone's personal and financial situation is unique. It is important that you consult a professional financial adviser, such as a CPA financial planner, to advise you on the latest developments in this field or if you have specific questions or need advice on developing a retirement planning strategy. |
Retirement planning is a lifelong endeavor. Recognizing this is the first step to ensuring a financially secure future. Unfortunately, statistics show that many of us don't realize the necessity of planning for retirement. According to a study conducted by the U.S. Department of Commerce, only 5 percent of all Americans are financially independent at age 65. This study further indicated that 75 percent of all retirees are forced to depend on family, friends, and Social Security as their only sources of income. You can protect yourself from falling into these statistics by planning NOW for your retirement.
Budgeting for the Future—How Much Money Will You Need?
The first step in planning for your retirement is determining what you will need to live on. In order to retire with financial security, you typically will need at least two-thirds to three-quarters of your pre-retirement income. Of course, this is a broad rule of thumb. You will have to estimate your needs based on your individual goals and desires. Consider factors such as the following in your estimates:
· The number of years you plan to be retired. This will be influenced by your planned retirement age, life expectancy, and health.
· Whether you plan to work part-time or as a consultant during your retirement years.
· The lifestyle you would like during those years, including where and how you plan to live.
· The rate of inflation between now and the day you retire. Many experts believe an assumed 3 to 4 percent annual inflation rate is a reasonable estimate for the next 10 to 20 years.
To estimate your needs, use your current budget as a starting point. Write down expenses, remembering that they will change when you retire. For instance, work-related expenses, such as lunches, clothing, and transportation, will be eliminated. However, you may incur additional costs for health care or even utility bills since you may be home more often. And with more free time, you may decide to spend more money on a hobby or travel. As you can see, whether your expenses increase or decrease is at least partly up to you. Once you've developed an initial estimate, it is advisable to periodically recalculate how much you will need as you get closer to retirement.
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Sources of Retirement Income
Once you know what you expect to spend during retirement, you'll have to figure out where your retirement money will come from.
There are four main sources of retirement income:
· Social Security
· Employer pension plans
· Personal retirement savings accounts
· Personal investments
The relative amount of each income source will vary with each individual, but some combination of all four sources is typically essential for a secure and comfortable retirement.
Social Security. Social Security is the foundation on which additional retirement plans can be built. Benefits are based on your average lifetime earnings on which you paid Social Security taxes. So the more you earn, the more you collect.
Contact your local Social Security office every three years for a copy of your earnings and tax record. You can also ask for an estimate of the benefit you will receive at retirement.
Employer pension plans. Pensions are part of the fringe benefit package offered to employees by most companies. Be aware that provisions vary from plan to plan.
One thing that all plans have in common is that they are "tax advantaged". This means that you pay no taxes on the contributions your employer makes in your name until you withdraw the money. Also, any earnings accumulate tax-deferred until you begin to collect your pension.
There are rules that limit the time it takes you to become fully vested in a pension plan. Plans must adopt either a five-year "cliff" vesting schedule or a seven-year "graduated" vesting schedule. With the "cliff" plan, you become fully vested in your pension benefits after five years. With the "graduated" plan, you gradually become vested over seven years, at which point you are fully vested. It's important to understand your plan's vesting provisions to estimate how much you can expect to receive at retirement.
Personal retirement savings accounts. These accounts are regarded by the Internal Revenue Service as "qualified" retirement plans with superior tax benefits. The following is a description of various personal retirement accounts. These descriptions are very general; there are many rules that impact the amount you may contribute, the date on which you can begin taking withdrawals, and the imposition of penalties. It is important to consult a professional financial adviser, such as a CPA financial planner, regarding these accounts.
· Traditional IRAs—If you are not covered by any employer-sponsored pension plans, you may deduct 2003 and 2004 IRA (Individual Retirement Account) contributions of up to $3,000 per year if single (up to $3,500 if you are 50 or older) and up to $6,000 if married (up to $7,000 if both you and spouse are 50 or older). If you are covered by a company-sponsored plan, you may still be able to make a tax-deductible contribution to your IRA, depending on your adjusted gross income. Earnings in your IRA grow tax-deferred until you withdraw the money.
· Roth IRAs—A relatively new type of tax-free, nondeductible IRA was created for tax years after 1997. Although your contributions to a Roth IRA are not tax deductible, all earnings accumulate tax-free. In addition, you will not pay tax on withdrawals from your account at retirement. You may contribute to a Roth IRA regardless of whether you are covered by a company-sponsored plan; however, the amount you can contribute may be limited, depending on you adjusted gross income.
· 401(k) Plans—The amount you contribute to a 401(k) is deducted from your gross income. Furthermore, any interest or dividends earned are tax deferred until you withdraw your money. Your plan documents should specify how much you can contribute annually.
· Keoghs—Self-employed taxpayers may establish Keogh retirement plans. Contributions to Keogh plans are deductible and earnings accumulate tax deferred. You may contribute up to approximately 20 percent of your net self-employment income, depending on which type of plan you choose.
Personal investments. If you want to maintain your current lifestyle, your own investment holdings should make up part of your retirement income. Do some investigating to decide which investments are best for you. In selecting investments, you should consider several factors, such as risk tolerance, time horizon, liquidity needs, tax implications and diversification. In addition, different investments are often appropriate for retirement accounts. It is a good idea to contact a professional financial adviser, such as a CPA financial planner, for assistance in developing an investment strategy that is consistent with your investment profile and retirement goals.
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Other Retirement Issues
In addition to planning for your financial needs, you will also need to consider lifestyle issues, such as:
· Whether to keep your home or move to a more suitably-sized residence.
· Possible relocation to another community.
· Your health.
· How you will spend your time (hobbies, travel, a second career).
· Handing over the reins of a family business.
It is important to consider these issues in your overall plans for retirement.
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Deciding When to Retire
The decision of when or if to retire is influenced by many factors. One consideration is your life expectancy. The present life expectancy is nearly 80 and the Census Bureau expects the percentage of those aged 85 or older to double within the next few decades. As a result, you may need retirement income for as many as 20 to 30 years.
Your employer's pension plan also affects your decision on when to retire. Your pension may be significantly reduced, or even eliminated, if you are not with the company long enough to be entitled to your full benefits. Provisions vary from plan to plan, so make sure you know and understand the eligibility requirements of your own plan.
Even if you have sufficient assets, your age can be an issue if you try to retire early. Tax penalties will be imposed if you withdraw funds from your IRA, Keogh, or other personal retirement accounts before a stipulated retirement age.
Your Social Security benefits are determined in part by your normal retirement age—the date on which you are eligible for your full Social Security retirement benefits. For these purposes, your normal retirement age is based on your birth year.
If you were born in or before the year 1937, your normal retirement age is 65 and you have three options regarding your benefits:
· Retire between 62 and 65 on a reduced benefit
· Retire at 65 on a full benefit
· Continue working and get a bonus for each year of work past your 65th birthday up to age 70.
If you were born between January 1, 1938, and December 31, 1959, your normal retirement age falls somewhere between 65 and 67. If you were born in 1960 or later, the age at which you can retire with full benefits is 67. You are still eligible to retire early at a reduced benefit or delay retirement for a "bonus" benefit.
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Setting Financial Goals
Planning for retirement requires setting concrete goals. Think about what you really want to do and how you want to live during your golden years. Then take a close look at your personal financial profile. Review your investments, insurance, credit rating, housing situation, and income to determine what you'll need for your future. Devise a budget and investment strategy to help you meet those goals.
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The Time to Start Planning Is Today
As you can see, planning for retirement involves careful consideration of many financial and lifestyle issues. You must decide how you want to spend your retirement years and then develop the financial and non-financial strategies to help you get there. And, as your retirement approaches, you'll have to determine the best strategy for withdrawing your retirement funds. A professional financial adviser, such as a CPA financial planner, is well-versed in the latest developments and planning ideas and can analyze your situation and develop the strategies to help you achieve your retirement goals.
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