All too often, the path to retirement is painted as a simple task that starts and ends when you open a retirement account. But a 401(k) may not always be enough, especially if you have larger goals for retirement, such as vacationing or traveling.
Furthermore, you’ll have to worry about limitations, such as inflation or taxation, which may make alternative vehicles, such as a self-directed IRA, more attractive.
If you really want to prepare for retirement–and be successful–you’ll need to perform your due diligence. Here are nine steps to help you prepare for retirement.
1. Start Making Retirement Goals
Asking yourself important questions about the hows, whats, and whens of your retirement will help you establish a vision, strategy, and benchmarks for your retirement planning. Here are some good questions to ask:
- At what age do I want to retire?
- How much money do I need for necessities like groceries, rent or mortgage, utilities, and health care?
- Will I receive any government benefits, such as a pension or social security?
- Do I have or plan to open a permanent life insurance account that accumulates a cash value?
- What type of things do I hope to achieve in retirement (e.g., travel, hobbies, etc)?
- Do I want to leave a legacy donation or monetary gift to loved ones or charity?
Answering these questions can help you determine how much money you’ll need and how aggressively you’ll need to save to meet your goals.
2. Open a Retirement Account
You can’t prepare for retirement without a retirement account. Several types of accounts are available, and depending on your needs and current situation, you may find that you have more than one. Here are two of the most common retirement accounts:
401(k)s are employer-sponsored, meaning your employer selects the investment plan, and contributions are taken out of your check regularly. Some employers match your contribution, meaning if you contribute 3% of your paycheck each week, your employer will also make a 3% contribution.
401(k)s are convenient because little administration or oversight is required. However, if you leave your employer, you’ll have to transfer funds to a rollover IRA, perform a 401(k) rollover to a self-directed IRA, or talk to your advisor about ways to transfer funds to another account.
Individual retirement accounts are standalone accounts that you can open regardless of your employer or work situation, provided you have an income. There are numerous types of IRAs available, including:
- Traditional IRA. Tax-deferred until withdrawal.
- Roth IRA. Taxed upfront and tax-free upon withdrawal.
- SEP IRA. For self-employed or employers who want to set up and contribute to employee IRAs
- SIMPLE IRA. For self-employed or small business owners that want to contribute to and allow employees to contribute to an IRA.
You can also invest in a self-directed IRA, which gives you more control over how you invest your money and opens up your options to include alternative investments, like cryptocurrency. Each of the IRAs above is also available in a self-directed form.
3. Build Your Savings
There are several vehicles by which you could build your retirement fund–retirement accounts, savings accounts, permanent life insurance policies, etc.–but you won’t make much progress if you don’t contribute to your account.
If you have a regular source of income, one of the best ways to build your retirement savings is to schedule repeat transfers from your personal account into one or more of your retirement accounts.
You can also choose to make one-off contributions to the savings or retirement account of your choice. For instance, you may decide that your annual tax return goes directly to your retirement.
Keep in mind that many retirement accounts have contribution limits. For instance, the IRS limits annual contributions to $6,000 ($7,000 if you’re 50 years or older). In addition, depending on the type of account you have, an excess contribution can result in fees or penalties.
4. Create a Social Security Account
For many workers, social security plays a major role in retirement. As such, your social security benefits should be factored in when you are planning for retirement.
You can set up a secure social security account by visiting SSA.gov. Once you set up your account, you’ll be able to see personalized retirement benefit statements for yourself and a spouse, if applicable. These estimates can help you further plan for retirement and determine how much you’ll need to save.
Signing up now will also enable you to keep track of your social security benefit eligibility and make it easier to receive benefits when the time comes.
5. Pay Off Debt
It may be tempting to prioritize retirement planning over that credit card balance or other debt, but doing so may not always be in the best interest of your retirement plans. If you have high-interest debt, pushing all your funds towards your retirement can backfire in the end.
For instance, let’s say your IRA account is expected to grow at 7%, but you have a $5,000 credit card balance with a 15% interest rate. You also have $300 in discretionary income that can be used to pay off your debt and put towards retirement.
If you put $100 on the credit card bill, you’ll pay $2,764 over 78 months. That’s $2,764 you could have out towards your retirement. However, if you pay $200 a month (or two-thirds of the funds you can use for debts or retirement), you’ll pay $950 in interest at a 66% reduction. You also will pay it off more than twice as fast, meaning you can start putting that full $300 into retirement faster.
That doesn’t mean you should only pay down debt and put retirement off. If you have a mortgage or a significant amount of student debt, you may want to speak to a financial advisor who can help you determine the right balance between retirement and debt payments.
6. Start Investing
Regular contributions to your retirement account can help it grow over time, but in most cases, investing is what drives growth.
You’ll likely have limited control over your investment if you have a 401(k) or another employer-sponsored account. Other investment vehicles, like traditional or Roth IRAs or index universal life insurance policies, give you more control over how you invest your money. Though custodians typically play a primary role in allocating retirement investment funds, account holders can still make top-level decisions.
If you want the most control over your assets, consider opening a self-directed IRA. These IRAs move investment control from the custodian or trustee to the account holder. As such, you have the freedom to invest in everything from compound interest investments, like bonds, stocks, and mutual funds, to alternative assets, like realty, tax liens, or even startups and venture projects.
7. Calculate Your Retirement Withdrawal Tax Rate
Retirement accounts generally carry tax benefits. Some accounts, like traditional IRAs, offer tax benefits upfront, meaning your contributions are from pre-tax dollars, but you’ll pay taxes when you make withdrawals during retirement.
Others, like contributions to a Roth IRA, are taxed upfront, meaning you won’t have to worry about taxes when you withdraw during retirement.
The rate at which your contributions or withdrawals are taxed depends on your income bracket. If you think your income tax obligations will be higher when you retire, then a Roth IRA may be more beneficial than a traditional IRA. However, a traditional IRA may be a better option if you think your tax obligations will be lower, a traditional IRA may be a better option.
If you already have a retirement account and know your withdrawals will be subject to income tax, then you can factor that into your retirement planning. However, if you don’t have an account, analyzing your current and potential future tax rate can help you decide what type of account is best.
You can find out your existing tax brackets and rates by visiting the IRS website. Keep in mind that tax rates do fluctuate over time. Therefore, use the available information as a guide but not as a final word.
8. Consider Working Longer to Keep Up with Costs
Inflation has become synonymous with our current financial environment, but it’s also a basic economic principle that will affect how far your retirement funds go. Based on the current IRS retirement regulations, individuals can take penalty-free withdrawals from their accounts by the age of 59 ½.
That may seem like an easy path to early retirement, but you may want to think again. Because the cost of living will inevitably go up between the time you open your account and the time you’re ready to enter retirement, your savings, even if well planned, may not meet your needs.
As such, working longer, even part-time, can help you prepare for a successful retirement while maintaining the lifestyle you want when paired with the increased cost of living.
9. Don’t Touch Your Retirement Funds
Most retirement accounts allow account holders to withdraw or borrow from their account to buy a home, pay for school, get married, or finance other needs. But should you?
Unless it’s absolutely necessary, it’s typically a good idea to leave your funds untouched until you reach retirement age.
When you take money out of your account, you lose out on valuable interest. That can derail your retirement plans. Even if you have the best intentions to repay the loan, life can sometimes get in the way. You may struggle to repay the loan, and the funds aren’t there when it’s time to call it quits.
Horizon Trust specializes in self-directed IRAs and other retirement accounts that help investors take control of their future. We also know that the best path to retirement is one that starts as soon as possible.
If you’re ready to start planning for retirement, contact us today. One of our experienced financial professionals can help you open a retirement account and start your path to the retirement you envisioned.