Retirement is leaving an active working life either by choice or involuntarily for the rest of your life. This is an exciting time for many people to get to do some things they always wished to do but couldn't due to being actively engaged in their careers. The retirement years are commonly referred to as your golden years. If you took the time to plan for your retirement and saved up enough from your working years, these are likely to be the best years of your life.
It is essential to plan and save for retirement as soon as you start working. Many younger people who enter the workforce think that retirement is far away and tend to ignore retirement planning only to find out years later that time flew by. If you are already working and haven’t started, the next best time is now.
According to the US Census Bureau, the average American retires at the age of 62. Half of the retirees leave the workforce earlier than planned mostly involuntarily due to health problems and disabilities or to care for a spouse. The average retirement length is 18 years. However, people are living much longer than before, often meaning that many of them don't have adequate retirement savings to see them through. They outlive their savings which is not an ideal situation.
Retirement can get confusing with all the jargon that is thrown around. This guide is meant to help you understand all about retirement. It will take you through all the questions that people ask about retirement and much more. For starters, get an overview through this two-minute commentary on saving for your retirement according to your age by Your Money, Your Wealth:
Table of Contents
When to Retire?
In America, there is no official retirement age. You get to decide when to retire. The average retirement age is 62 years. Retiring before 60 years is typically considered early retirement. 65 is deemed to be standard retirement age, while 70 and beyond is definitely a late retirement. The Internal Revenue Service will penalize retirement withdrawals from your IRA and other retirement financial instruments before the age of 59 ½.
You can claim Social security benefits at 62, but these will be 75% of the full amount. To get the full amount, you'll have to wait until you are 66. If you wait till 70, you boost your social security benefits significantly.
Deciding when to retire is a complex decision that you need to seriously think about. There are other issues to consider in addition to the factors to do with defined ages to access your savings and social security.
One of the factors is whether you have enough savings to see you through retirement. Nowadays, we are seeing that many people get to retirement age without adequate savings, thus finding themselves working well past the standard retirement age. To avoid this, start by creating healthy financial habits e.g planning for all your expected spending thereby improving your savings for retirement as well as future needs. This guide on how to manage your money expounds on other effective daily habits that are useful in saving up for retirement.
Health problems are another factor. Some health problems can physically prevent you from working again. Mental health is also a significant factor influencing retirement. Before retiring on health grounds, it is important to note that you'll only become eligible for Medicare once you get to 65. Health care costs can significantly affect your retirement savings if you are paying out of pocket.
There are many reasons to retire early and depending on how much you are engaged with your work and your industry, you will find different ways to achieve this goal. Check out this 7-minute video by Wes Moss which can help you reevaluate your planned retirement age.
How you will spend your retirement years will also heavily influence the timing of your retirement. When to retire is a personal choice based on your unique needs and circumstances. Hopefully, the video by Wes Moss was able to help you decide whether to do so sooner or later. The key takeaway here is to adequately prepare for retirement.
Saving Towards Retirement
Determining the amount of money from your current income to save towards retirement is not an easy thing. There are many 'Rules of Thumb' out there and many theories about the amount and percentages of our annual income we should be saving. You have probably heard of the 10% rule, the 80% rule, and the 4% rule. All these are useful benchmarks that help us determine what we should aim to save for our retirement. SmartZone finance enables you to set a good financial target for retirement in this short video.
There is also the other school of thought that says you should as much as you can. This is actually good advice. Saving as much as you can should be the goal. However, as we will see in the next chapter, it's not just about saving but investing the savings as well so that they can earn some interest. You can then maximize the compounding power of money. The various rules of thumb offer a good benchmark, which you should gauge yourself against.
However, a retirement calculator that takes care of the numerous variables will help you greatly in determining how much money you should be saving. Factors such as your age, inflation, future income, social security benefits, and other important variables.
Types of Retirement Plans
Now that you have decided to start saving for retirement, where do you put your money? In the US, there are many places where people save and invest their retirement funds. The best places are those retirement accounts that enjoy a tax deferral status where any money saved from your income to these accounts is not subject to income tax. The funds are only taxed much later when you withdraw the money in retirement. This helps protect your money and grow your retirement savings over the years, which is very important. Let us look at these retirement accounts in greater detail below. For starters, check out this 4-minute video by MoneyCoach, for an overview of the different retirement accounts that are available to you in the United States.
401(k), 403(b) and 457
These are very popular retirement plans mostly offered by employers. They are set up by the employer hence vary from employer to employer. They are almost similar plans only that 403(b) is offered by tax-exempt or not for profit organizations. 457 plans are offered by state and local governments as well as some not for profit organizations.
Many employers match a dollar for every dollar that the employee saves up to a certain percentage of your income. It is highly advisable to contribute as much as your employer matches as this is free money you are getting. Money from both the employee and the employer are taken pretax. You only get to pay income tax when withdrawing money from these types of accounts during retirement. The advantage of this is that withdrawals during retirement, known as distributions, will attract a lower tax rate. Additionally, your retirement savings will have grown and compounded tax-free.
For the average person, and to the extent that your employer offers this type of plan, then this will be a sufficient and easiest retirement plan. Most employers will manage the account for you and decide where to invest the funds in the plans. If they don't, it will be your responsibility to decide where the funds in the accounts should be invested in.
For solo entrepreneurs or independent contractors, you can set up a solo 401(k). A solo 401(k) is similar to the ones offered by employers, the only difference being that you set it up and manage it on your own. You can make contributions as both the employer and the employee to a maximum of $57,000 per year.
The contributions limit for 401(k) in 2020 is $19,500. Since this is a defined contribution plan and an employer can contribute to your retirement savings, but both the employee and employer contributions are capped at a maximum of $57,000. There is a provision for people aged 50 years and older to contribute $6,500 more through a Catch-up contribution.
The main advantages of 401(k) and 403(b) are;
- Tax-advantaged status
- Employer matching contributions
- Some employers manage the funds on behalf of the employees
- High contribution limits
IRA and Roth IRA
These are other popular retirement savings accounts. The acronym stands for Individual Retirement Account. The IRA is also known as Traditional IRA to differentiate it from the Roth IRA. They enjoy tax shield just like the 401(k)s but differently.
The traditional IRA and the Roth IRA differ in terms of when they are taxed. In traditional IRA, just like in a 401(k), money is taken pretax and then taxed upon distribution or withdrawal. For Roth IRA, the money out is already taxed, and hence withdrawals are not taxed.
The limit for both the IRA and Roth IRA is $6,000 per year and an additional catch up of $1,000 per year for those above 50.
In previous times, pensions plans were very popular. Civil servants working for the government and other employers would offer a pension as an employee benefit. It was enough for a person to retire on a pension and live comfortably. Once retired, the employee could choose between a lump sum payment or fixed payouts from the common pool. Nowadays, pension plans are not as common.
As we have seen with the three retirement plans we have talked about; there are limits set out in law or by your employer as to the maximum amount you can save and get upon retirement. Some people may want or have the ability to save more than these limits. This is where investment funds come in. They include index funds, mutual funds, stocks, real estate, bonds, certificates of deposits, and commodities. These investments are a great way to grow wealth while securing your financial future.
These investments offer a different rate of returns and variable risk. It is better to involve a financial adviser to help you spread out your investments across different levels of risk and reward.
Personal savings accounts are a great way to accumulate money. They help you save even small bits of extra disposable money over an extended period of time. However, one big disadvantage with savings accounts is the low level of interest offered by the banks. In some cases, the interest is not enough to beat inflation; hence you may end up losing wealth over the long term. On the other hand, it is good to have money in your savings account to take care of any emergencies. This helps you not raid your retirement accounts.
Owning a piece of real estate is a common retirement plan. Upon retirement, you can liquidate your ownership to get an income. It is common to hear of reverse mortgages. This is where you start getting paid as you live in your house for a fixed period of time until ownership changes. Another option for retirees is to downsize their home and move into a smaller home. They sell their previous home and buy a smaller one, often cheaper, to live in and use the extra money for their retirement expenses. To learn more about reverse mortgages, watch this short video by USA Reverse.
Social Security Planning
The social security program is like an insurance program or a financial safety net run by the government to provide some earning to people upon retirement or disability. Even though the monthly payouts are nowhere near enough to rely on as retirement income, it is still an important revenue stream.
Social security planning is part and parcel of your overall retirement planning. That's why we have dedicated a chapter for it in this guide. Social security retirement benefits are your hard-earned money, which you contributed over your working years.
You must work for at least ten years to be eligible for benefits. The longer you work, the better. If you work for 35 years, your social security monthly payment is likely to be higher, since the average of your 35 highest-earning years are taken into consideration with a cap of $137,700 per year for 2020. If you worked for less than 35 years, the missing years would be substituted with a $0 drastically bringing down your average.
The amount of monthly payout you receive will depend on your earned income before retirement, the age you start claiming the benefits, and the number of years worked. The amount you receive is adjusted for inflation regularly.
The maximum monthly payment you can get for social security is currently set at $3,790, making it $45,480 per year. However, not many people get to receive the maximum payout.
Once you apply for benefits, these past earning are taken into account, adjusted for past inflation, then your Primary Insurance Amount (PIA) calculated. PIA is also known as the full monthly benefit. This is the amount of money you are set to receive each month if you claim at the full retirement age. If you claim earlier than this age, the PIA is reduced accordingly. If you claim later, it is increased by 8% each year until 70.
The full retirement age will depend on when you were born. For those born between 1943-1954, the Full retirement age is 66 years. For each subsequent year, the full retirement goes up by two months up to 1960 and later when the age is 67.
You can only claim benefits when you are at least 62 years old. However, this will result in lower monthly payouts over your lifetime. You will receive 25% less your PIA or full monthly benefit. Delaying collecting the benefits until you are 70 increases the possible amount you can receive. Waiting past 70 doesn't increase your benefits. This is better illustrated with an example.
For someone born in 1954, the full retirement age is 66 years. Let's give them a PIA or full monthly benefit of $2,000. If they were to claim at 66 years, they would receive the whole amount of $2,000. If they were to claim at 62 years, they would receive 25% less, which is $1,500. If they were to wait till 70, they would receive $2,640. Remember, all these amounts are periodically adjusted for inflation. To better understand this, check out this 4-minute video from Devin Carroll.
The advantage of claiming early is that you get to claim for a longer amount of time. Claiming late means you get a significantly higher monthly payout. The best age to claim your social security benefits will depend on your personal circumstances. The main factor is how long you expect to live. If people in your family generally live long, then it would be better to wait until you are 70.
Best States to Retire by Retirement Taxes
The state you retire in will significantly impact your retirement income. Tax rates across different states differ. That's why you often hear retirees heading to some states, but is it advisable to relocate to another state for tax reasons? Before we answer this question, let's first look at a short background to understand why this matters.
Retirement income is mainly derived from several sources. The main ones are social security monthly payouts, distribution from IRAs, 401(k)s and other retirement plans, pension schemes, investments, savings account, and real estate.
Some taxes will tax some or most of this income, while others will not subject it to tax. Relocating and living in a tax-friendly state may be the key to ensure that you outlive your retirement savings while still enjoying a high quality of life. It can also ensure that whatever you leave behind for your dependents is not gobbled up by high taxes.
Moving to a state that is retirement friendly is a good choice. Federal law prohibits states from levying taxes on retirement income earned from another state.
According to research by Kiplinger, the breakdown of retirement tax friendliness is as follows:
The 10 most tax-friendly states for retirees:
5. South Carolina
The 10 least tax-friendly states for retirees:
7. Rhode Island
8. New Jersey
10. New York
Tips for Saving more for Retirement
- Start saving as early as you get your first paycheck. If you haven't already, the next best time is now.
- If your employer offers a dollar for dollar match, contribute as much as they are matching.
- Even if you are in a 401(k), consider opening an IRA.
- If you are 50 years plus, take advantage of the catch-up contributions offered to both 401(k) and IRA accounts.
- If your employer doesn't deduct your retirement savings from the payroll or if you are self-employed, automate your retirement savings.
If you are unsure of how much you need to save for retirement, use this simple retirement calculator created by Bankrate.com.
Making the decision to relocate is a difficult one for many retirees. Being close to family and other support systems is increasingly important at this age. Other factors such as the weather, access to social amenities, efficient infrastructure will heavily weigh on your decision. However, sometimes, you have to relocate to avoid high taxation. The key here is to balance between financial security and quality of life.
Retirement Planning for Gig Economy Workers
The gig economy has grown tremendously over the last decade. More and more Americans are either working in the gig economy on a part-time or full-time basis. Gig economy includes self-employed people, independent contractors, freelancers, consultants, etc.
Freelancers and "solopreneurs" can also prepare for retirement with great flexibility using IRAs. To get an overview of the options to be discussed in this section, watch this 6- minute video by Investing with Rose to learn about your retirement investment options.
The flexibility of work and other benefits that gig economy workers face come with great responsibility. One of these is retirement planning. They have to plan their retirement and set up a plan where they'll save for their retirement. Unfortunately, a considerable percentage of gig economy workers do not have a retirement plan.
Most of them are simply not aware of the various options available to them. The downside to this is that time is not on their side. The earlier one starts saving for retirement, the better.
Some of the retirement plans we had looked at earlier and are available to gig economy workers are;
- Traditional IRA
- Roth IRA
- SEP IRA
- Simple IRA
- Solo 401(k)
Whichever plan fits your circumstance, always remember that retirement saving is not and should not be an afterthought. It should be an integral part of how you manage your finances.
Should I keep working in retirement?
If you are worried that your retirement savings are not enough to last you the rest of your life, then working in retirement is a good option. However, at this age, it is possible that you may have health problems that make it difficult to continue working. Working part-time is a good option if you are able to. Other than the financial incentives, it offers mental, physical, and emotional benefits. However, if for any reason or no reason at all, you don't want to work in retirement, it's perfectly fine. It's your time to enjoy your golden years having worked during your youthful years.
Is social security enough to cover my retirement expenses?
Unfortunately, the answer to this question is no. Social security will only cover a small fraction of your retirement expenses. It is a wrong and even dangerous strategy to expect to live off social security.
When am I eligible for Medicare benefits
You qualify for Medicare benefits once you get to 65 years and have accumulated 40 credits. Keep in mind that Medicare may not cover all your medical expenses. You may need to supplement it with the so-called Medi-Gap policies or pay from your pocket.
Should I relocate to save my retirement savings from high taxes?
This is a dilemma that many retirees often have to contend with. On the one hand, you are anxious if your retirement savings will be enough to last your lifetime. Paying high taxes will only reduce these savings. On the other hand, you do not want to move far away from family, friends, community, and other support systems you have around you.
Thus it becomes a balancing act. Relocating is sometimes the better option. If you decide to go for it, don't be afraid of leaving behind your familiar surroundings. You'll often find that in cities with favorable retirement taxes, numerous retirement communities are welcoming.
The key to getting this right is thinking about it before retiring and deciding where to live in retirement early enough.