How to Plan Financially for Retirement

By 2040, average life expectancy among those who reach age 65 is projected to rise from age 81 to 85 for men and from age 84 to 88 for women, according to the National Center for Health Statistics. While that's good news, it also means that careful retirement planning is more crucial than ever before.

Instructions

Difficulty: Moderate

1. Project your life expectancy (see 295 Make Your Final Arrangements and 499 Live to Be 100 Years Old). Most financial planners use age 85 to 90 as a conservative estimate. The longer you live, the more money you'll need to save.
2. Read 228 Design a Savings Plan. Estimate how much money you will need in retirement. Financial planners recommend that you estimate retirement expenses to be about 80 percent of expenses before retirement. That should allow you to maintain the nearly the same standard of living you now enjoy. If you plan on traveling a lot or want to buy a second home, you're going to have to save about 10 percent more. Figure in 3 to 5 percent for inflation.
3. Calculate a balance sheet to evaluate assets and liabilities you will have accumulated by retirement. Assets are what you own, liabilities are what you owe. Take into consideration retirement plans that don't have the fixed income payout of pension plans, such as 401(k), 403(b), Section 457 plans, profit-sharing plans and IRAs. Don't forget to include income from potential inheritance, and profits that may come from things like selling your home for a less expensive one. See 239 Track Your Investments and 247 Plan Your Estate.
4. Estimate your retirement income sources. Retirement income comes from four main sources: Social Security benefits, pension and retirement accounts, personal savings and investments, and wages from income earned during retirement. Social Security benefits don't kick in until you're 62, and benefits increase if you wait until you're 65. If you do start receiving your benefits earlier, consider investing at least a portion of them.
5. Live modestly. If you work hard toward saving now, you'll achieve your goals of retiring sooner. It may mean making a few sacrifices, but it will pay off in the long run. See 15 Live With Less.
6. Maximize your tax-deferred and tax-free savings opportunities. Take advantage of employer-sponsored retirement plans such as 401(k), 403(b) and 457 plans. You wouldn't pass up free money, so be sure to fully fund any portion of a 401(k) that is being matched by your employer and max out your contribution if you can. If you have savings that exceed the maximum allowable amount in your employer-sponsored retirement plan, your IRA is just the place to stash it.
7. Invest consistently. Saving a certain amount at scheduled intervals has become easier, in part due to defined-contribution options such as 401(k) plans. These are good start-up investments because your employer automatically deducts the money from your paycheck and often matches your contributions.
8. Fund your traditional or Roth IRA to its maximum. Thanks to recent changes in the tax code, the yearly contribution maximum is $3,000, with the maximum escalating to $5,000 in 2008. The Roth IRA also allows you to withdraw funds early without incurring a penalty--a definite plus when you consider that Social Security benefits may not kick in until your 60s, or later, if Congress pushes out the age limits.
9. Talk to an experienced financial planner about your goals and the best way to reach them. A good financial pro will be able to offer you a second opinion on your plans and offer suggestions on the best strategies for meeting your goals.
10. Take some risks and diversify your stock portfolio. That doesn't mean putting all your money into penny stocks, but it does mean having a greater percentage of your investments in higherearning equities rather than the more cautious treasury and savings bonds that many people select as they get older. Look carefully at how much of your money goes into the stock of the company you work for. As any Enron employee will tell you, having the majority of your money in one asset can leave you dangerously undiversified.
11. Calculate how long it will take for your investment to double. To figure this out, divide the annual rate of return by 72. At a 7 percent return, your money will double in 10 years and quadruple in 20. Financial gurus call this "the rule of 72."
12. Consider pooling resources with siblings and other family members to buy long-term care insurance for your parents, if they might not be solvent enough to take care of themselves financially should they need elder care. Taking care of your parents can sap your ability to work full-time and can drain your savings.
13. Get your other paperwork in order. See 243 Create a Living Trust, 245 Execute a Power of Attorney, 247 Plan Your Estate and 244 Make a Will.

Tips & Warnings

• Even with limited resources, you can invest through other avenues such as mutual funds. The minimum investment requirement for 900 of the 10,000 funds tracked by Morningstar is $250 or less (See Resources).
• It helps to know just how big that check will be. Uncle Sam makes this easy. Check out the Social Security Administration site (see Resources).
• Complete a retirement planning worksheet to figure out how much you need to save. Investment management firm T. Rowe Price has such information; click on "Individual Investing" (see Resources).
• Save 10 to 15 percent of your pre-tax household income and the maximum possible in all the retirement planning options available to you. It reduces your taxes today and builds funds for your future.
• If you start investing $100 a month at age 25 in a retirement account that gains 10 percent a year, by 65 you'll have $632,000. But if you wait until you're 35, you'll only take away $226,000.
• Rule of thumb: If you don't start saving until you're in your 40s, you'll need to set aside 20 percent of your gross income. If you wait until your 50s, your target will have to be 30 percent. As a last resort, you may have to sell your house and car, get a second job and reduce discretionary spending. The sooner you start saving, the easier it will be to reach your goals.
• Somewhere in all of the paperwork that you'll sign before you walk out the door of your job may be a form that asks whether you want your accumulated pension to come to you in one big chunk or in monthly payments. Talk this over with your accountant or financial adviser before signing.
• Eliminate credit card debt. It's the single biggest threat to an early retirement.