Retirement Planning

Retirement Planning Definition

Retirement planning is planning for a financially secure life after retirement. It is preparing and strategizing for the future to meet one's survival, goals, and aspirations even after attaining old age and not being a part of the working population. The plan depends on individual requirements, hence is different for individuals.

In most countries, the average life expectancy has increased due to improved healthcare and standard of living. This, however, puts pressure on the government's financial systems, and it becomes difficult to provide pensions and other benefits for all. Similarly, due to rising inflation, the current cost of living will not suffice. Therefore, a retirement plan is inevitable.

• Retirement planning is planning and strategizing for the future retirement life. It involves saving and investing money periodically and strategically to achieve individual goals and aspirations.
• Individuals can grow their money with certain tax benefits through several popular investment vehicles, including individual retirement accounts (IRAs) and 401(k) s. Regardless, investments should be made per one's risk tolerance.
• Any person can start planning for retirement; however, the earlier, the better. Longer periods of investment provide a bigger advantage of compounding interest.

Retirement Planning Explained

Retirement planning is a form of investment for one's future. With the increasing life expectancy and cost of living expenses, it becomes all the more necessary in modern times. On average, people across the country are expected to live 70-75 years (the average lifespan for men and women is 73.8 and 68.4, respectively).

The average retirement age in the United States is 60 years. However, as years go by, the average life expectancy may increase to 100, and the retirement age may not change due to population growth. Therefore, early retirement planning is important. 

Rising inflation and dwindling interest rates are other reasons to start early retirement plans. This will increase financial freedom and reduce dependency on other people. Apart from these, fulfilling individual goals and aspirations is one of the major reasons to start a retirement plan. After retirement, most people relax and think about what else they can do in life.

However, it is a time of uncertainty and therefore needs meticulous planning. Since they involve investments, they are not immune to market fluctuations or volatility. Like every investment, they also carry risks. Long-term investments especially can help avoid the risk of these fluctuations. Apart from this, long-term investments aid in compounding interest.

Types Of Retirement Planning 

There are several different options for retirement planning for people to choose from. Some of the common investment plans are as follows:

#1 - Actively managed mutual funds

Mutual funds are perfect options for individuals who don't want to pick their statements. Instead, a qualified fund manager can decide and take action on their behalf. Many stock kinds are available for investment, including foreign stocks, technology companies, American stocks, corporate bonds, etc. Fees and flexibility are the biggest negatives of this option. Fees for actively managed mutual funds are greater than other investment vehicles since someone else is choosing the stocks.

#2 - Index funds

Index funds are similar to active mutual funds. These funds follow a benchmark index, such as the S&P 500 or the inclusive MSCI World Index. The returns of index funds are identical to the index they track.

#3 - Exchange-traded funds

ETFs are similar to typical mutual funds in that they hold various assets, such as equities or bonds, and many follow a benchmark like index funds. However, the difference is that one can buy and sell them at any moment of the day and have value in real-time.

#4 - Target date funds

Target date funds, a form of all-in-one mutual funds or ETFs that automatically change their asset class mix as individual age increases, are one of the market's most favored 401(k) investments. A retirement planning calculator can help in planning for such cases.

#5 - Traditional Individual Retirement Account (Traditional IRA)

Individuals can designate their retirement savings through the IRA, a fee investing vehicle. As the name indicates, it’s a personal account that individuals open and fund personally. IRAs come in various forms with differing tax obligations, depending on the person's employment situation.

Traditional IRAs and Roth IRAs differ from one another in a significant aspect. In Roth IRAs, the investments make use of after-tax money. Hence there is no tax deduction for invested money on withdrawal. However, in the case of traditional IRAs, taxes will be due as soon as money is withdrawn because it allows pretax contribution and reduces taxable income for the year.

#6 - Simple IRA

Small businesses may offer a SIMPLE IRA or Savings Incentive Match Plans for Employees. Similar to a 401(k), it allows contributions from employers and employees, which lowers each party's taxable income by the amount invested by each party.

#7 - Traditional 401(k) plans

A 401(k) is an employer-sponsored retirement account provided to employees. Contributions grow tax-deferred like those made to a standard IRA. When individuals withdraw those funds, they have to pay taxes, but if their retirement tax band is lower than it was during their working years, the tax they owe shouldn't be too high. Compared to an IRA, the contribution limit is higher.

#8 - Roth 401 (k)

The employer sponsors this account, and the post-tax money funds it. Similar to the Roth IRA, contributions are not tax-deductible, but individuals won't owe taxes on their withdrawals either. Employees and employers can contribute, but there are restrictions, just like a traditional 401(k). If under 50 years old, one can contribute a maximum of $20,500 to a Roth 401(k) in 2022.

#9 - Simplified Employee Pension (SEP) Plans

The SEP plan may be the ideal choice in retirement planning for self-employed individuals. This account, which can only be opened by business owners who employ one or more people or are self-employed, works similarly to a traditional IRA in that pre-tax contributions lower your taxable income (or the company's, depending on who contributes). In addition, money can grow tax-deferred until individuals withdraw it in retirement.

#10 - Stocks for future growth

Investments made for the long term give better returns. This is possible directly through mutual funds or exchange-traded funds. However, they involve risks. When markets fall, the returns also fall. Therefore, one should choose stocks depending on their risk tolerance. Diversified equity funds, as opposed to individual stocks or investments in small sectors, are the best method to reduce exposure to market volatility.

#11 - Bonds

Investors lend money to a government or business in exchange for a yearly payment based on a predetermined interest rate. Individuals receive their initial investment back after the term of that bond. Depending on the type of bond purchased, a certain annual income is guaranteed, and less risk is involved. Therefore, bonds tend to vary less than stocks, balancing a portfolio's overall ups and downs.

#12 - Alternative asset classes

There are numerous types of investments available, and most experts recommend holding 5 to 10% of assets in investments other than stocks and bonds. Due to its propensity to increase in value during economic recessions and the significant market falls, gold is a good option. One can also buy other commodities, such as silver or oil, or one can experiment with futures and options depending on their risk appetite.

Stages

This is how retirement planning should ideally take place:

• Starting as early as possible: Time is the deciding factor. The longer the period, the more returns. The time provided gives space for compound interest to work effectively. Early retirement planning is, therefore, a necessity.
• Make a list of current expenses: Experiencing one's preset expenses reveals the nature of their lifestyle. This, in turn, helps in evaluating how much a person will need to maintain their current lifestyle in the future (including inflation) and upgrades if any. This list can include travel aspirations, entertainment, and loans due.
• Giving priority to investing: Maintaining discipline is the key. Short but steady investments pave the way for great returns. A similar focus shall be given to building a balanced portfolio. A retirement planning calculator can determine the investment needed for the goals.
• Debts: Being free of debt means retirement savings are free from any obligations. Paying off high-interest rate debts early on saves interest accumulation and provides breathing space for investments.
• Emergency fund: An emergency or contingency fund is important. Unexpected expenses such as medical or hospital bills can burn a hole in the individual's pocket. Planning for the future will help face them.
• Setting up automatic payments: Automatic transfers from one bank account to another can help maintain discipline. In addition, they are helpful for debt repayment and investments.
• Check for tax efficiencies: Understanding how returns will be taxed in the country where one resides is critical. Therefore, one should make plans accordingly.
• Long-term wealth accumulation: Individual goals and aspirations vary. They should lay out investment plans according to their targets and aims. Investing in equities can be an option for long-term investments.
• Not depleting the retirement fund: Individuals can divide their investments into increments to achieve their short-term objectives. In addition, an emergency fund can help save situations requiring immediate financial attention.
• Monitoring: Investments should be monitored between intervals and changed if needed after considering market performances and goal changes. Investing can be switched to low-risk options during the retirement period.

Frequently Asked Questions (FAQs)

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This article has been a guide to Retirement Planning and its definition. Here, we explain its different types and various stages. You can also go through our recommended articles on corporate finance –

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