How to Financially Prepare for Retirement

Ryan Smith |
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When financially planning for retirement, there are basically two phases:

Phase one looks like working for an employer, saving a portion of your paycheck, and making investments with those savings.

There are a multitude of ways to invest – which we will cover in our next blog article – each with varying levels of market volatility. In addition, there are a wide range of savings accounts to place your gains that maximize your retirement savings.

Phase two starts once you retire, when you’ll be covering your day-to-day expenses with those savings and/or a steady income stream, be it through real estate, your investment gains, or social security.

Relying on only one of these sources of income during this financial transition, however, can risk your retirement expenses outweighing your available funds.

How much do you need to be saving for retirement?


To determine the amount you need to save, start by writing down a list of ideals for your retirement including housing, location, and lifestyle goals.

What do you want to see when you visualize your future? This image will determine your financial management strategies, so the more detailed and precise, the easier it will be to execute.

 

Think about the things that are non-negotiable like:
 

  • Housing costs; mortgage, taxes, and utilities.
  • Living essentials; food, toiletries, and clothing.
  • Insurance; Medicare and Medicare supplements.
  • Transportation; car payments, insurance, fuel, and maintenance.
     

These costs have to be included as they are unavoidable.

 

Next, think about how you’d like your lifestyle to be in retirement and what it would include. Do you want to travel? What sorts of hobbies would you like to pursue?

Calculate Your Retirement Expenses              


Online tools like benefits and expense calculators are an invaluable method for getting a comprehensive picture of your finances.

When calculating retirement expenses, there are two types of costs to account for; committed and discretionary. Your committed, or fixed, expenses cover long-term investments like a mortgage on a property or car payments.

Discretionary expenses, or variable expenses, are short-term costs that can be scaled-back, such as travel, luxury goods, or your entertainment budget.

 

Prior to your actual retirement, it’s advisable to eliminate as many monthly payments as you can or discuss other solutions – like leveraging your home equity to retain ownership – with a financial professional.

Estimate Your Monthly Benefits


To estimate your monthly benefits, the key question is when will you retire? If you plan to retire early, it factors into the amount of social security you’ll receive as opposed to if you file for delayed benefits.

As awkward as it can be to talk about, the life expectancy of you and your spouse also need to be taken into account when financing retirement – an important factor as human longevity and life expectancy increases. 

 

Other possible monthly benefits like disability, survivors, or a pension from a government job should also be included in your retirement plan.

Maximize Your Retirement Savings

 

There are various strategies for wealth, but none quite as impactful as efficient tax planning.
There are several ways to execute a tax plan, one of which is moving to a “tax-friendly” state, like Florida.

 

The less sandy strategy is to start a retirement savings account. An employee-sponsored retirement plan like a 401K, a traditional individual retirement account (IRA), or a Roth IRA are the most common. There are several different sub-categories, each with their own benefits and rules.

Retirement Savings Accounts


Depending on which type of savings account you place your retirement savings into will impact the amount you’ll pay in taxes. But before comparing accounts, there are a few key terms to understand, namely AGI and MAGI.

 

Your AGI, or your adjusted gross income, is used by the IRS to determine your income tax liability for the year, and is calculated by subtracting certain expenses – like student loan interest payments or business expenses – from your gross income.

Your MAGI is your AGI after certain deductions or tax credits are applied. In regards to retirement, your MAGI determines the rules that govern how much you can contribute to your qualified retirement account(s). 

 

Qualified Retirement Accounts

 

Qualified retirement accounts – 401(k)s and Traditional IRAs – are employer-sponsored pension programs that include both a defined-benefits plan and a defined-contribution plan, and must be made equally available to all employees.

401(k)s are taken pre-taxed directly from a taxpayer’s earrings, and provides a tax break to your employer for matching your contributions. These retirement accounts also allow you to place your gains into savings, deferring taxes until you make a withdrawal, also known as a “pre-tax contribution.”

 

Traditional IRAs provide the employee an immediate tax break because they [the taxpayer] can take a tax deduction for their contributions in the year they make them.

When the withdrawal is made, typically after retirement, both their contributions and earnings are then taxed. If the withdrawal is made pre-retirement, however, fee penalties may occur.

Non-Qualified Retirement Accounts

 

Non-qualified retirement accounts, like a Roth IRA, do not have to be equally available to all employees and do not offer tax credits to employers for matching contributions.

These taxed contributions are made the same year they are earned, and enables tax-free growth and tax-free withdrawals in retirement. Certain taxpayers that have a high MAGI, however, cannot contribute to a Roth IRA, as this account type has an annual contribution limit.

Required Minimum Distributions
 

Most qualified accounts have required minimum distributions (RMDs). RMDs require the account owner to begin withdrawing by April the year after they turn 72. A Roth IRA account, however, does not have RMDs and withdrawals are not required until after the owner’s death.

Ask your financial advisor about how to avoid getting killed in taxes when making these mandatory yearly withdrawals. One option is a conversion from one type of retirement savings account to another.

Retirement Tax Planning Strategies


In order to maximize your tax savings, your financial professional may suggest making a Roth IRA conversion. This particular conversion transfers assets from a traditional IRA to a Roth IRA and allows the account holder to receive future tax-savings. 


This conversion is achieved by either:
           

  • Strategically moving traditional IRA assets into a Roth IRA
  • Converting your whole traditional IRA to a Roth IRA
  • Rolling over your pre-taxed earnings from your 401(k) into a Roth IRA

 

Another strategy your financial professional may suggest is doing a Backdoor Roth IRA Contribution. This strategy can accommodate those high-income earners with existing 401(k)s at their place of employment.

There are nuances that must be navigated in these strategies, however, an experienced financial planning professional can surely help determine how to do so. 

 

To better determine your best tax saving options, please ask your financial advisor. Consider reaching out to Rivettas Wealth Strategies to create the retirement you want to see.

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