Some people retire by choice. Others do so involuntarily, often as a result of corporate restructuring or downsizing that has cut the ranks of middle management over the past years. Even if a person does not intend to retire early, or is only in their twenties, planning for retirement should begin now. The sooner it is initiated, the easier it will be, regardless of whom decides when it is time to retire.
Pretend someone you know has just retired. Consider how he or she will live the rest of their life. Where and how will he/she live? This exercise can help flesh out dreams and desires.
Although it is difficult to determine exactly how much money will be needed in thirty or more years, estimate how much this lifestyle will cost. One way to do this is to base an estimate on current spending and lifestyle – then adjusting for long term inflation.
The less money that is needed to live on, the easier it will be to retire early. Do not make plans so ambitious that they will never be achievable. Use the following guidelines:
• Most people manage on 65%-80% of pre-retirement income
• You will spend less on home, clothing, savings, etc.
However, remember that most will probably spend more on health care and travel after retirement. There will be more time to travel. Unfortunately, the aging process will probably increase medical outlay.
Once having decided how he/she wants to live and determined roughly how much it will cost, compare that with a projected income:
• Company and other pension payments
• Social Security (over age 62)
• Insurance or mutual funds to annuitize for income
• Calculate after-tax profit from home sale
If you plan to sell your home, the proceeds could generate additional income. However, now consider the rent required for the type of home that would meet your post-retirement needs – as well as the location. There are no ceilings on rent increase.
• Other liquid assets to produce additional cash
All investments can produce income to supplement the ability to retire. However, you must retain some liquidity and keep a portion of the funds invested to offset inflation.
HOW TO ACHIEVE YOUR GOAL
Determine how much will need to be saved each year between now and the time that you retire in order to finance needs. For this, it is wisest to consult with a financial planning specialist since there are many factors to be considered.
The best way to reach goals is to maximize income during peak earning years and develop disciplined saving and investment habits. Traps to avoid:
• Giving too much of your money to the government in taxes
• Failing to put enough money into appreciating assets
These include financial investments, art, and the right real estate.
• Giving too much money to creditors in interest payments
• Spending too much on intangible expenses
This might include rent, utilities, entertainment, and travel.
• Spending too much on depreciating assets
These might include furniture, clothing, boats and cars.
It is not enough just to save. Save smart by:
• Letting Uncle Sam contribute
Do this by making the most of tax favored-retirement plans, including (traditional IRA plans, Roth IRA plans, Keoghs, tax deferred annuities and investment-oriented variable life insurance.
• Letting your employer contribute.
Participate to the maximum if a company has a participatory 401(k) plan. Any type of plan that permits making contributions before taxes will compound funds much faster. Furthermore, the investment return is not taxed and there is some element of creditor protection.
• Check to see the amount of retirement money vested.
Do this before quitting a job. Another few months could make a big difference if your vesting were to rise, say, from 60% to 80% vesting.
• Opening a Keogh account with money from a second job.
• Do not go overboard on extravagances.
Add the additional money to the retirement account. In fact, if someone has been under-contributing to the qualified retirement plan, increase deductible contributions to the maximum, and if necessary consume the balance of the excess. The tax leverage will be substantial.
• Consider a Roth IRA rollover.
The 1997 Taxpayer Relief Act created the Roth IRA that has a tax-free income provision. One can rollover a traditional IRA, pay tax now, and then have tax-free (rather than taxable) income at when you retire. The decision should be based on age, planned time to retire, tax bracket, and expected earnings. Professional advice to make this decision may be beneficial.
Do not put off until tomorrow what should be done today. The earlier one starts saving, the greater the benefit because the money will have time to compound over the years.
Tom Fischer is a Financial Planner in Scottsdale, Arizona specializing in Early Retirement Planning.