Planning for retirement does just mean considering where you will live or which hobby you will take up. Financial planning is exceptionally important, and it can make the difference between a decent retirement where you mainly stay at home and watch your funds – and hope you’ll be fully covered in the event of an expensive medical issue or another financial catastrophe – and a financially independent retirement where you don’t have to worry about such things.
Which would you rather have?
The second, to be sure is a no-brainer. But how do you get there? That's where prudent financial planning can help.
#1 – Determine how much money you are going to need
A pretty standard estimate is that you will need approximately 70% of your pre-retirement income in order to live comfortably. In general, that will work if you are in excellent health and you have fully paid off your mortgage.
However, that is not the case with most people. And in particular, what happens if you take on a really big expense such as building a dream house or getting an advanced degree? Those voluntary expenses can be as big as the involuntary ones for major medical issues. Medical expenses are likely to increase during your retirement, particularly if you retired before Medicare kicked in and you need to buy your own health insurance. Health insurance, outside the contributions from an employer, tends to be expensive. And with the current uncertainty surrounding what will happen to and/or replace the Affordable Care Act, do not expect the costs to go any lower – and they could very well rise considerably.
#2 – Determine how you are going to meet your retirement expenses
That is, where is that money going to be coming from? Your main sources of income are likely to be 401k and/or Individual Retirement Accounts (including both Roth and traditional IRAs), pensions, income from stock dividends or sales or bond sales, real estate or business investment income, tax-deferred annuities, and Social Security. Plus there is whatever is in your savings account.
These various funding sources have specifics with reference to when you are taxed, and how much you can take out. Be sure to consult your tax professional for guidance.
Funding sources which will tax you before you retire
Want to minimize your taxes during your retirement? Then consider a Roth IRA or Social Security payments.
Funding sources which will tax you after you retire
That’s just about everything else.
With a traditional IRA, your taxes are deferred until retirement, and the same is true with a tax-deferred annuity. It may also be true with any pension funds you get. With stocks and bonds, you may end up having to pay capital gains taxes on any proceeds from sales. Real estate and business investment income will likely also be taxable as well.
One more funding source
This one will definitely be a ‘taxes paid after you retire’ asset, but it’s not to be overlooked. It is your home. Houses are often the most significant purchases many people make in their entire lives. For people who live in higher cost areas where the housing market favors the seller, selling your home can be a great way to add funds to your retirement. Under the Taxpayer Relief Act of 1997, married couples do not have to pay capital gains taxes on the first $500,000 in profits from a home sale if they have lived in the home for at least two of the most recent five years, or one year if they ended up in a nursing home. Singles get a $250,000 exemption. There are even some exemptions even if you fail the use test for residence. Depreciation deductions for home offices are deducted from these exclusions.
And where will you go? It does not have to be a nursing home, at least not in the beginning. Your options tend to improve as you go farther south in the United States, and prices tend to decline as well. You could find you sell your home for the better part of a million dollars in the northeast or California or a large city like Chicago and then move to a condo in a place like Naples, Florida (it is on the Gulf side, near Fort Myers) and pay $200,000 – in cash.
#3 – Determine if you will have enough to retire on
So, among all of these sources, will you have enough? CNN has a great retirement calculator where you can enter certain variables to figure out if you are on the right track – or not. Plug in your current age, your estimated retirement age, your current savings, your present-day salary, and what percentage you are saving toward retirement.
CNN also has an asset allocation tool which is meant to show how your assets should be mixed if you factor in your tolerance for risk, the time when you need the money, and your desire and ability to take advantage of sell-off opportunities.
As a supplement to these calculations, also check out Social Security’s retirement estimator. This estimator asks for your personal data (and that includes your Social Security number) and then plugs in your estimated retirement year and what you believe you will earn, on average, between now and the day you retire. Social Security provides estimates based upon whether you will retire at age 62, 67, or 70. Age 62 is considered to be “full retirement”. You can also add different year estimates in order to compare figures. You may be surprised at how little a difference there can be between, say, a retirement at age 70 and a retirement at age 75, when it comes to your Social Security monthly payout. Naturally, deferring retirement for five years can help you save money in other ways, from allowing for more income to be accumulated to receiving more employer contributions to your savings funds, your health insurance, or both.
When it comes to your retirement, you can never plan too much or start planning – and saving – too early.
This material is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.
To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes.
Distributions from traditional IRA’s and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59 ½, may be subject to an additional 10% IRS tax penalty.