For most people, retirement is the biggest financial goal they’ll have. But as you probably know, planning for a goal that’s possibly decades away can be easier said than done.
To help make this pursuit less intimidating, we’ve put together a guide to help you through the retirement planning process. Whether you’re five years from retirement or 30 years, the steps below can help you feel more confident in your finances and know that you’re on the right track.
How do I create a retirement income plan?
A retirement income plan is a guide for how you’ll provide for yourself during retirement. Essentially, it takes all of the hard-earned money you’ve built up over years of saving and investing and helps you see how it will supplement your lifestyle during your retirement years.
Building your retirement income plan is a long process that ideally starts years before you actually retire and may involve the help of a financial planner. You’ll consider the amount you have in your retirement accounts and the amount of income you expect to need during retirement and turn it into an actual income plan.
Like most things, a good retirement income plan really starts with understanding your goals. Once you know your financial goals for retirement — including when you plan to retire and how much income you want per month — then you’ll be able to determine how much you’ll need to save and what investments are most appropriate.
The good news is you don’t have to DIY your retirement income plan. The Personal Capital Retirement Planner can help you determine whether you’re on track for retirement and, if not, what you need to do to get there.
What is the most popular retirement income plan?
When it comes to investing for retirement, there’s no shortage of options available to help you. While there’s not one retirement plan that’s right for everyone, we’ll share a few of the most common to help you understand what’s most applicable to you. .
1. 401(k) Plan
A 401(k) plan is the most popular type of retirement plan available to American workers. This plan is offered by private-sector employees. It allows workers to contribute a percentage of their income into a pre-tax retirement account. Per the IRS, workers can contribute up to $20,500 per year in 2022, with an additional catch-up contribution of $6,500 for workers age 50 and older. It’s also become more common for companies to allow for Roth 401(k) contributions in addition to the standard pre-tax option.
2. 403(b) Plan
A 403(b) plan is quite similar to a 401(k) plan, and the two are subject to the same contribution limits and regulations. The key difference between the two is that while private-sector employees usually have access to a 401(k) plan, a 403(b) plan is more common for school and non-profit employees.
3. Traditional IRA
An individual retirement account (IRA) allows workers who are not offered an employer plan to invest towards retirement, or allows for additional savings outside a company’s plan. As of 2022, the IRS allows for annual contributions of up to $6,000. Tax-deductibility of contributions to an IRA is dependent on whether the individual is covered by an employer plan, and their modified adjusted gross income (MAGI).
4. Roth IRA
Investors can choose to invest in a Roth IRA instead of a traditional IRA. The two are similar in many ways, including their contribution limits. The key difference is that Roth IRA contributions are made after-tax, with withdrawals being tax-free during retirement. However, there’s an income limit on who can contribute to a Roth IRA, meaning many high-income individuals aren’t eligible.
5. SEP IRA
For self-employed folks, a SEP IRA is a great retirement savings tool. A SEP IRA allows self-employed individuals to contribute up to 25% of their income or $61,000, whichever is less This plan can be used for sole entrepreneurs, as well as for small business owners with employees, and is funded by employer contributions. It’s advisable to consult a tax advisor to determine if this plan is appropriate.
6. Solo 401(k)
A Solo 401(k) is another popular retirement plan for self-employed individuals. This type of plan can only cover a business owner and their spouse. Like the SEP IRA, the Solo 401(k) allows for a total contribution of $61,000 per year. The difference is you aren’t necessarily subject to the 25% maximum that you are with the SEP IRA, and you’re also allowed an employee contribution and catch-up contribution (if 50 or older) just like any other 401(k). Again, advisable to engage a tax advisor to determine if this plan makes sense for you.
7. Pension Plan
Defined-benefit pension plans are becoming less common in the private sector because they’re more expensive and put more of the risk on the employer rather than the employee. With this type of plan, workers get a guaranteed income during retirement based on their years of service with an employer and their salary while they worked there. A small percentage of private-sector companies still offer pension plans, as do government entities to their employees.
What is a good retirement income per month?
There’s no one size fits all answer for what is a good monthly retirement income. Instead, it’s important to get a grasp on your monthly spending, and find the best target income to accommodate the lifestyle you desire.
It’s likely your income needs will be lower during retirement than they are during your working years. First, you no longer have many of the expenses associated with being in the workforce, including commuting, a work wardrobe, etc. Additionally, you’re no longer delegating savings towards retirement each month.
Another reason many people spend less during retirement is that many target to have paid off their mortgages by the time they retire. And since housing is the largest line item in most people’s budgets, you could actually significantly reduce your income needs.
On the other hand, there may be some expenses that will increase during retirement. Many people see their healthcare costs rise meaningfully during old age, which will require more disposable income for that purpose. Additionally, if you plan to travel or take up other new activities during retirement, you’ll need to account for that in your budget.
According to the U.S. Census Bureau, the median retirement income for Americans age 65 and older is $47,357. In general, financial experts recommend a target retirement income of between 70% and 80% of your pre-retirement income. For example, if you have an income of $60,000 before retirement, you should aim for $42,000 to $48,000 during retirement.
What is the 4% rule for retirement income?
One of the most useful tools to help you determine how much you should save for retirement is the 4% rule. According to this well-known rule, you can safely withdraw 4% of your savings during your first year of retirement. During each subsequent year, you adjust the original amount based on inflation. If you follow this rule, the assumption is that you will have enough savings for at least 30 years.
Let’s say your savings at the time you retire total $1 million. According to the 4% rule, you could comfortably withdraw $40,000 during your first year of retirement. And each year after that, you would adjust your withdrawal based on the current inflation rate. Because your withdrawals are tied to inflation, you might increase your withdrawal more during some years than others.
The 4% rule was created by financial advisor William Bengen in the 1990s. It has been widely cited by advisors since then. However, there are also plenty of critics on either side of the argument. Some claim that 4% is too much, while others argue that you could safely withdraw more.
It’s also worth noting that this rule leaves little room for flexibility or different scenarios. It’s also based on the stock market returns from one 50-year period, meaning there’s no guarantee it will stand the test of time. The 4% rule can be a great starting point, but know that it may not perfectly work in your situation.
5 Steps to Take Now
Given all the nuances involved, it’s no surprise that retirement planning can feel so overwhelming. And while everyone’s situation is unique, there are some steps that everyone can take today to make some progress toward their retirement income plan.
1. Calculate your estimated expenses during retirement
The first step to building your retirement plan should be estimating how much income you might need. You could simply rely on the 70% to 80% rule of thumb that many advisors use. However, you may also want to sit down to understand how you’re spending today and how/if that can be adjusted in retirement. Doing so can help to ensure you aren’t planning for less income than you’ll actually need based on your financial goals.
2. Take inventory of your current retirement savings
Once you’ve got an idea of how much income you might need during retirement, take some time to calculate your current savings earmarked for cash flow in retirement.. This step will be useful in determining whether you’re on the right track.
3. Consider your other sources of retirement income
Remember that the funds in your retirement accounts may not be your only source of income during retirement as you’ll likely be receiving Social Security retirement benefits. In fact, these benefits represent a significant source of income for today’s retirees. Many younger generations are hesitant to rely on this income during retirement due to the program’s financial state, but at this point, those benefits are still expected to be available in some capacity..
In addition to Social Security, you may have other passive income sources to consider.. For example, if you own rental properties, ideally you’ll have income coming in from those investments. You may also have recurring income from other investments outside of your retirement account(s) that you expect to tap into during retirement.
4. Calculate how much more you’ll need to save for retirement
Once you know how much income you’ll need during retirement and how much you saved today, you can determine your shortfall. Using this information, you can determine how much you should be setting aside each month to meet your retirement goals.
Remember, you don’t have to do this step yourself. The Personal Capital Retirement Planner can help you determine your savings goal based on your current retirement savings, the age you want to retire, and how much income you expect to need during retirement.
5. Craft your investment strategy
Whether you’re investing your money yourself or working with a financial planner to do it on your behalf, it’s important to make intentional decisions about where you invest your retirement funds. There are many options available, and the appropriate portfolio strategy for you will depend not only on your retirement goals but also on the level of risk you’re comfortable with.
As you near retirement, it’s likely that your investment strategy will change. In general, you’ll want to reduce your investment risk as your time horizon gets shorter.
If you’re creating your retirement plan, you don’t have to go it alone. Personal Capital’s free financial tools can help you get on the right track with your retirement plan. And when you’re ready to take the next step, Personal Capital can connect you with a financial advisor who can walk you through every phase of retirement planning, from setting your retirement goals to choosing your investments.