A retirement plan is a financial strategy that combines both savings and investments and plans for distributions to pay for retirement. To help assist you with your financial goals, employers often offer a 401(k) plan to help you save a portion of money from your paycheck in order to save for retirement. But not all employers offer them. If your employer doesn’t have a 401(k) plan or other such tax-advantaged account, an individual retirement account (IRA) will help you save assets for retirement as well. We’ll go over how to strategize a retirement plan.
If you need help planning for retirement and building income streams, consider working with a financial advisor.
Understanding Retirement Plans
Broadly speaking, retirement plans asses the income you will need during retirement. They generally do this by estimating expenses or using your current income. Then, retirement plans guide workers and, if necessary, provide recommendations if they aren’t quite on track to meet their retirement goals.
There is no one-size-fits-all retirement program. Each retiree has their own set of goals and expectations. Some people will be comfortable assuming more risk for the chance of greater returns, while others prefer to play it safe.
However, retirement plans usually involve saving and investing a portion of your salary for a period of years or even decades. Enacting a retirement plan and strategy over the long term usually provides the greatest chance of success.
Defined Benefit vs. Defined Contribution
Taking a closer look, defined benefit and defined contribution plans are two broad categories of retirement plans. While there are many differences between them, defined benefit plans, of which there are fewer and fewer, usually come in the form of pensions. On the other hand, defined contribution plans are usually employer-sponsored retirement plans, like 401(k).
Defined benefit plans offer a guaranteed monthly benefit when an employee retires. Typically, this benefit is calculated using a formula that uses the employee’s salary, among other factors.
Conversely, a defined contribution plan doesn’t offer a guaranteed monthly benefit. Instead, money in a defined contribution plan is invested in assets like mutual funds. In some cases, the employer also contributes to the plan. When the employee retires, he or she can draw the funds from the account, including any gains or losses. Because there is no guaranteed monthly benefit, the employee can decide how much to withdraw each month.
How Retirement Plans are Invested
Retirement plans can be invested in several ways, which depend in part on the type of account. For example, if you have a 401(k) through your employer, your money may be invested largely in mutual or exchange-traded funds.
These professionally managed funds pool money from many investors in securities like stocks and bonds. Some employers may offer target date funds as a 401(k) or 403(b) investment. As you get closer to retirement, these funds are adjusted to be less volatile.
There are many other ways to invest retirement funds, especially if you have an IRA. Unlike employer-sponsored plans, you can open an IRA with an online brokerage. And an IRA can unlock a much wider range of investments.
Those include not only stocks and bonds but also money market funds, real estate, and in some cases, cryptocurrency. However, it’s best to meet with a financial advisor if you want to build your own retirement portfolio.
How Much Money Do You Need for Retirement?
One of the most important questions in planning for retirement is determining how much money you need to live on. While some general numbers can give us guidance in this area, the truth is that the real number varies from person to person.
For instance, a common recommendation is that you should aim to have about 80% of your current income in retirement. For example, if your current salary is $50,000, you should aim for a $40,000 income after you retire. Depending on who you ask, that $40,000 may or may not include income sources like Social Security or a pension if you have one.
To give a simple example, suppose you retire at 62 and expect to live 20 more years. If you assume you won’t rely on Social Security or other income sources at all, you will need an $800,000 portfolio to draw your $40,000 per year. That also assumes your portfolio neither increases nor decreases in value during that time.
Retirement Plan Distributions
You can generally begin taking distributions from your retirement plans once you retire or reach age 59 ½. For Roth plans, you can generally take distributions from the plan before age 59 ½ without a penalty once at least five years have passed since making the contribution.
Taking your retirement plan distributions is in some ways as strategic a process as your contributions. The goal is generally to maintain a stable and predictable income without the risk of running out of money.
As Charles Schwab puts it, “Social Security, pension payments, annuities, interest income or even cash or short-term bonds kept in reserve are among the stable and predictable sources of income you can use to cover necessities like housing, car loans, food, and utilities.”
It continues by suggesting that retirees fund discretionary expenses with growth assets like stock dividends and distributions from mutual funds and ETFs. This is likely because income from growth assets is not always guaranteed, so it’s best not to rely on it for things you need.
Retirement planning can refer to the strategic decisions that go into thinking about your finances after you retire. However, the term can also retire to the accounts that hold your retirement funds, such as a 401(k). Retirement funds are usually invested in mutual funds or ETFs, which contain securities like stocks, bonds and money market funds. You may also have a pension. But these plans, known as defined benefit plans, are becoming rare in the private sector. Work with a financial advisor to build the best retirement plan for you.
Tips for Retirement
- A financial advisor can guide you through major financial decisions, like determining your investing strategy. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Deciding how to invest can be a challenge, especially when you don’t know how much your money will grow over time. SmartAsset’s investment calculator can help you estimate how much your money will grow to help you decide which type of investment is right for you.
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