Making a plan and sticking to it is the first and likely most important step for a successful retirement journey. You are making money, budgeting, saving, and investing. But how do you know if you are on the right track. Are there specific things you could be doing to help you meet your goal? Well, there are some tips many have used in the past to have a successful and more efficient retirement journey.
Now keep in mind that everyone is different. Some may get there sooner, and some later. And there is no one correct path to a successful retirement. Everything discussed here will not necessarily apply to everyone. We will also assume that the average individual will retire in their mid-sixties.
Further, this post is not meant to be an all inclusive and comprehensive discussion of everything you can possibly do to be successful. There are certainly many different actions one can take to help them achieve a successful retirement journey.
Nevertheless, it may be wise as well as motivating to use certain commonly used techniques many others have used successfully to help you reach your goals.
Twenties: Your Retirement Journey Begins
Your twenties are arguably the most important decade in your retirement journey. This is where your career begins. And maybe even more importantly, this is where you establish good habits such as consistent saving and investing. Not to mention actively shunning consumer debt.
Now you can make an argument that your retirement journey begins in high school. The logic behind this is that your high school performance can determine which college you get into. The college you attend can potentially determine your earning power, and how your career will turn out.
For our purposes, however, we’ll take the position that your retirement journey begins once you graduate from college. Once you do so, it’s time to start earning some money so that you can meet your goal of retiring from work some day. The sooner you start, the easier it will be to accumulate enough to meet your goals. The power of compounding is strongest over longer time periods.
Some born entrepreneurs may start a business immediately and never look back. But for most of us, this is a stage in life where you get a job, make some money, and get some valuable experience.
Contribute to Tax-Deferred Retirement Plans
Qualified retirement plans such as 401ks and IRAs allow your money to grow on a tax-deferred basis. This is a great benefit as it allows the portfolio to compound and grow even faster.
Hopefully your employer sponsors an employee retirement plan such as a 401k, in which you can participate. You cannot be excluded from participating in an employer’s qualified retirement plan once you reach age 21 and have at least 1 (401k plan) or 2 (other plans) years of service. However, your employer’s plan may be less restrictive than this.
Once your participation is effective, you should try to contribute as much as you can afford into such a plan within the allowable limits. Besides saving for retirement on a tax-deferred basis, your employer may also contribute to your savings via a “match.”
If a retirement plan is not available from your employer, you can contribute to an Individual Retirement Account (IRA). The contribution limits are lower, and there won’t be an employer match, but it is still a very good alternative. You can open an IRA account at just about any brokerage firm.
If you are self-employed, you have several options. See Small Business Retirement Plans – Prepare For The Future Today for more information.
Save and Invest A Portion Of Your Earnings Consistently
You should aim to save at least 10 to 15% of your gross income for future goals. At this point, most of these savings will be directed into your retirement accounts (401k, IRA, etc.).
However, some should go into establishing an emergency fund. A savings or money market account may be good options for this purpose. For additional yield on your emergency fund, short-term CDs or a CD laddering strategy may also be good options.
With regard to your investments, your time horizon is long. Your risk tolerance should therefore be relatively high. Volatility should not be an issue as you will not use these funds for several decades. So you should therefore have a relatively higher allocation to equities. Putting 90 to 100% in equities will maximize the growth of your portfolio over the long term.
Make sure to regularly reinvest income generated from your investments to maximize the effect of compounding. This can be done automatically with mutual funds, for example. Also make sure to diversify your investments and invest regularly.
Besides saving and investing in your retirement plans, you will have begun to earn credits towards your Social Security Retirement Benefits by working.
Minimizing Debt And Other Considerations
Avoiding consumer debt should be a priority. Paying off student loans may also be an important goal. See Are You Drowning in Debt? for more information on managing debt.
Estate planning documents should also be in place early on. You can and most likely will need to update them as the years pass. At a minimum, draft a basic will, and keep your beneficiary designations up to date for any insurance policies and retirement accounts.
Your independence is satisfying, but you are also becoming more responsible. Maybe you have your own car and auto and health insurance policies by this point. You may also be saving some cash for a down payment on a home.
Don’t forget, however, that money you expect to use within a relatively short time period should not be invested in volatile assets such as stocks or long duration bonds.
Twenties Savings Goal
By the time you are done with your twenties, you should aim to have at least 1x your salary accumulated in retirement and other accounts you will use when you retire. Keep in mind however, that the actual amount saved, in your twenties especially, will depend on several factors. These can include when you finished school and how soon thereafter you started working. Not to mention how much you saved, how your investments performed, etc.
Thirties: More Money But Also More Responsibilities
By now you should hopefully have some promotions under your belt. You are also likely making significantly more money than you were in your early twenties. Maxing out the contribution limit of your employer retirement plan may even be an option now. Or at least it’s within reach. Maybe you even have extra funds to contribute to an IRA as well.
However, responsibilities may also be growing by this time. You very possibly may have purchased your first home. Hopefully you’ve avoided consumer debt, built up good credit, and have accumulated some assets. This can make it easier to qualify for a home mortgage and get a good rate.
Not to mention you may be married and possibly ready to start a family. If you haven’t done so already, that is. If this is the case, monetary obligations will be growing exponentially. They can include:
- Saving for college – You should contribute to tax advantaged savings vehicles such as 529 plans.
- Purchasing various insurance products (life, home, disability) – You need to protect yourself and your family from the unexpected. Otherwise, a boutu of misfortune can derail your retirement journey.
- Raising children – These costs can include just about anything. Healthcare, food, and clothing are some examples.
On the plus side, you may be lucky enough to be in a two income household. Armed with several years of experience, you may even be looking to go out on your own and start a business.
Thirties Savings Goal
Your time horizon is still very long, so you will want to try and maintain a relatively aggressive asset allocation. Before you reach forty, you should aim to have at least 2.5 to 3.0 times your salary saved up for retirement purposes.
Forties: Obligations Persist and Income May Be Peaking
This decade contains the midpoint of the retirement journey for many individuals. Most of the same obligations from the previous decade usually persist during your forties. You are likely still supporting dependents, paying down the mortgage, and continuing premium payments on a term life policy, for example.
Children may also be entering college at this time. So you may start to dip into your college savings which you’ve hopefully accumulated by now. But scholarships and tax credits can also help pay for college. See Tips to Help You Save and Pay for College for more information.
Your income is possibly peaking. Besides potentially maxing out your employer retirement account and IRA, maybe you’re also able to save even more money in a taxable investment account. Or you may be looking at alternative investments such as rental properties, for example.
Forties Savings Goal
With regard to asset allocation, you may wish to start dialing back the stock portion of your portfolio a bit. A gradual reduction to about 70% to 80% in stocks may make sense during this decade. This can start to add some more balance and stability as you start to get somewhat closer to retirement.
Your retirement savings should contain several times your annual salary by now. Aim to have at least 4.5 to 5 times your salary saved up before you reach your fiftieth birthday.
Fifties: Earnings May Not Be Growing, But Expenses May Be Lightening Up
Of course everyone’s income and job situation is different. But for many individuals, income may have stopped growing by now. Many even reduce their work hours and responsibilities before full retirement. However, income can still be high compared to the earlier part of your career.
But cash obligations may be lightening up by now as well. Children may be finishing college. Finding work and ultimately moving out will mean fewer individuals dependent on you financially. This can mean savings on health insurance, life insurance, clothing, food, utilities, etc.
Many even downsize to a smaller home and save on property taxes as well. Either way, hopefully your mortgage will be paid off by now. Or at least you are very close to accomplishing this great feat.
A good income with fewer financial obligations can mean an opportunity to save more for retirement. This is especially true if you’ve been lagging up to this point. Once you reach 50 years of age, the government allows for “catch-up” contributions by essentially expanding the contribution limits of plans such as IRAs or 401Ks.
Many individuals will work part-time before they retire from work completely. As such, they may wish to supplement their earnings with distributions from their retirement savings. Others may just want to dip into their nest egg sooner for another reason. But if you do so too soon, you may face an IRS penalty.
You Can Start Taking Early Retirement Distributions Without Incurring a Penalty
You can begin taking money out of qualified retirement plans such as IRAs and 401Ks without incurring the 10% early withdrawal penalty once you reach age 59 1/2.
However, you may potentially also be able to withdraw money by age 55 from a qualified employer retirement plan such as a 401K without incurring this penalty. You can do so if distributions are made to you after you separate from service from your employer in or after the year you reach age 55. Separation can be due to disability, quitting, retiring, or being terminated by the employer.
A public safety employee can avoid the penalty after turning 50 if the distribution is from a governmental defined benefit plan after separation from service.
There are also other specific exceptions where you may be able to make withdrawals from such plans before age 59 1/2 without penalty.
Fifties Savings Goal
You may wish to gradually lower your stock allocation to around 60 to 65% before your fifties are over. Again, this is just a guideline based on a retirement age of about 65 and a relatively long life expectancy. Retirement savings should be at least 6.5 to 7 times your salary before you reach sixty.
Sixties: Retirement Beckons
Your working career may be winding down. But you may still wish to work part-time. Regardless, this is traditionally the decade where most individuals retire from work. By the time you reach retirement around your mid-sixties, you should have at least 7 to 8 times your salary in your nest egg.
Now you may think this is a relatively small amount of your salary to have by the time you retire. Especially if you expect to live into your nineties, for example. Based on the well known 4% safe withdrawal rate, you’d think you may need 25 times your salary. But things will make more sense when you consider the following:
- You have not been living on your entire salary since you’ve been saving at least 10 to 15% of your earnings each year. So you’ve been using a maximum of 85 to 90% of your earned income on average, over the years.
- Living expenses during retirement are estimated to be about 80% of pre-retirement expenditures on average.
- Social security retirement benefits replace about 40% of the average earner’s salary (not living expenses).
Regardless, those who start saving early on in their careers can usually accumulate much more than these rules of thumb recommend. So there is some room for error for most individuals. Things don’t always work out as planned. As such, don’t get too discouraged if you lag a bit behind some of the savings milestones discussed above. That being said, there is no reason to make things difficult by waiting until your forties and fifties to start saving for retirement.
Asset Allocation During Retirement
Inflation can be a very big threat to retirement portfolios over the long term. It can be even more so if you are too conservative in your portfolio allocation. Putting too much money in “safe” assets such as bonds and cash equivalents may be riskier than you think. With individuals living longer, you want to minimize the risk of running out of money in your old age. Your time horizon can still be relatively long in retirement.
As such, in order to keep up with inflation and maintain the purchasing power of your nest egg, you still want to be invested in equities during retirement. A stock allocation of about 50% may accomplish this goal. This is discussed in some more detail in How Much Do You Need To Retire?
Social Security and Medicare
If you are a widow or widower, you can start collecting survivor benefits as early as age 60. If you are disabled, you can do so by age 50. This will be a reduced benefit based on your deceased spouse’s record. You can switch to your own retirement benefit it it’s more. This can be done as early as age 62.
However, you receive your full Social Security Retirement Benefits after you reach your full retirement age (FRA). This can be as early as 65, or as late as 67, depending on when you were born. See Social Security Retirement Benefits – Key Points You Should Understand for more information.
You also qualify for Medicare benefits once you reach age 65. A supplemental medigap policy may also make sense for many individuals.
You may be able to receive full benefits from an employer defined benefit pension plan without separating from employment once you reach age 62.
Full pension benefits (defined benefit plan) must begin within 60 days after the close of the latest plan year in which you:
- turn 65 (or the plan retirement age if earlier), or
- complete 10 years of plan participation, or
- terminate service with the employer
Seventies: Last Call
If you haven’t retired in your sixties, you may wish to do so in your 70s. Or maybe you’re one of the lucky few who don’t consider their job or business to be work.
Either way, 70 is the longest you should wait before you begin collecting your Social Security Retirement Benefits. You cannot increase your monthly benefit amount by waiting longer. Especially for those who do not really need the money, this strategy of delaying benefits can pay off if you live long enough. But it can also backfire if you die sooner than expected. The opposite also holds true. Taking benefits at 62 or 65, for example, and living long enough after that can result in a lost opportunity as well.
Required Minimum Distributions
You also cannot wait forever to take distributions from traditional qualified retirement plans. For most individuals, this is not an issue. Nevertheless, required minimum distributions (RMDs) are required to be made from your tax-deferred retirement plans by April 1 after the year you turn 70 1/2.
This includes IRAs and 401k plans. However, in order to avoid potential higher taxes by having two years worth of distributions in the same year, you may wish to take the first one by December 31 of the year you turn 70 1/2.
A qualified employer retirement plan may allow participants to delay RMDs until after retirement as long as they are not 5% owners.
Keep in mind that Roth IRAs do not require distributions until after the account owner’s death.
The retirement journey can be a long one. As such, it is imperative first and foremost that you enjoy the ride. As long as you start early, establish good habits, and stay the course during the eventual difficult times, you will reach your destination!