What Is Retirement Planning? Steps, Stages, and What to Consider

By Julia Kagan
Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

What Is Retirement Planning?

Creating a retirement plan begins with determining your long-term financial goals and tolerance for risk, and then starting to take action to reach those goals. The process can begin anytime during your working years, but the earlier, the better.

The process of creating a retirement plan includes identifying your income sources, adding up your expenses, putting a savings plan into effect, and managing your assets. By estimating your future cash flows, you can judge whether your retirement income goal is realistic.

Needless to say, a retirement plan is not a static document. You’ll need to update it from time to time as well as review it to monitor your progress.

How Retirement Planning Works

A retirement plan is your preparation for a good life after you’re done working to pay the bills or at least done working a full-time job. But it’s not all about money.

The non-financial aspects include lifestyle choices such as how you want to spend your time in retirement and where you’ll live. A holistic approach to retirement planning considers all these areas.

The goals for your retirement plan will change in focus over time:

• Early in a person’s working life, your contribution to retirement savings may be modest. The reward is 40-plus years of investment growth.
• During the middle of your career, when your income may be at its peak, you might set specific income or asset targets and take steps toward achieving them.
• Once you reach retirement age, you go from accumulating assets to what planners call the distribution phase. You’re no longer paying into your retirement account(s). Instead, you start collecting the rewards of decades of savings.

How Much Do You Need to Retire?

Your magic number, which is the amount you need to retire comfortably, is highly personalized. But there are rules of thumb that can give you an idea of how much to save.

• People used to say that you need around $1 million to retire comfortably.
• Other professionals use the 80% rule, which states that you need 80% of your current income to live comfortably after retiring. So, if you made $100,000 per year, you would need savings that produce $80,000 per year for roughly 20 years, or a total of $1.6 million.
• Others say most of us aren’t saving anywhere near enough to meet those benchmarks and should adjust our lifestyles accordingly.

Estimating Expenses

Your post-retirement expenses largely determine that “magic number.”

It’s a good idea to create a retirement budget, calculating estimated costs for housing, health insurance, food, clothing, and transportation.

And since you’ll have more free time on your hands, you may also want to factor in the cost of entertainment, hobbies, and travel.

It may be hard to come up with concrete figures, but a reasonable estimate will be helpful

Steps to Retirement Planning

Regardless of where you are in life, several key steps apply to almost everyone during their retirement planning. The following are some of the most common:

1. Come up with a plan. This includes deciding when you want to start saving when you want to retire, and how much you’d like to save for your ultimate goal.
2. Decide how much you’ll set aside each month. Using automatic deductions takes away the guesswork, keeps you on track, and takes away the temptation to stop or forget depositing money on your own.
3. Choose the right accounts for you. Invest in a 401(k) or similar account if your employer offers that option. If the company offers an employer match and you don’t sign up, you’re giving away free money. Whether or not there’s an employer match, you’re getting a good deal tax-wise.
4. Check on your investments from time to time and make adjustments. This is especially important after a big event, like marriage or a baby.

Retirement Plans

Tax-advantaged retirement savings plans have become the keystone of long-term savings for Americans. You should have access to one or more of these plans depending on how you earn a living. Each has its own rules and regulations.

Employer-Sponsored Plans

Most large companies offer their employees 401(k) plans. Nonprofit employers have similar 403(b) plans.

An upfront benefit of these qualified retirement plans is that your employer has the option to match what you invest up to a certain amount. For example, if you contribute 3% of your annual income to your plan account, your employer may match that amount, depositing the sum into your retirement account along with your contribution.

You can contribute more than the amount that will earn the employer match. Some experts recommend contributing upward of 10%.

401(k) Limits

The maximum is revised yearly by the Internal Revenue Service (IRS). Participants can contribute up to $23,000 in 2024 ($23,500 in 2025) to a 401(k) or 403(b), some of which may be added to with an employer match. People age 50 and older can contribute an extra $7,500 per year as a catch-up contribution in 2024 and 2025. Those aged 60 to 63 can now make a catch-up contribution of $11,250 in 2025.

These accounts can earn a much higher rate of return than a savings account (although the investments are not risk-free). The funds in the account, if it is a traditional account rather than a Roth account, are not taxed until you withdraw them. Since your contributions are taken off your gross income, you will get an immediate income tax break.

Those who are on the cusp of a higher tax bracket might consider contributing enough to lower their tax liability.

Traditional Individual Retirement Accounts (IRAs)

The traditional individual retirement account (IRA) is similar to a 401(k) plan, but it can be obtained at virtually any bank or brokerage. It is primarily for self-employed people and others who have no access to a 401(k), but anyone with earned income can invest in an IRA.

The money you save in an IRA is deducted from your income for the year, lowering your taxable income and, therefore, your tax liability.

The tax benefit to this kind of account is upfront. So when it comes time to take distributions from the account, you are subject to your standard tax rate at that time. Keep in mind, though, that the money grows on a tax-deferred basis. There are no capital gains or dividend taxes that are assessed on the balance of your account until you begin making withdrawals.

Roth Individual Retirement Account (Roth IRA)

A Roth IRA is funded with post-tax dollars. This is a great variation on the IRA, with a little more pain upfront for a lot of gain down the road.

The Roth IRA eliminates the immediate tax deduction of the traditional IRA. The money you pay into it is taxed in that year.

However, you should owe no taxes when you start withdrawing money, either on the amount you put in or the investment gains it accrued.

Starting a Roth IRA early can pay off big time in the long run, even if you don’t have a lot of money to invest at first. Remember, the longer the money sits in a retirement account, the more tax-free interest is earned.

Roth Limits

The 2024 and 2025 contribution limit for either IRA (Roth or traditional) is $7,000 a year, or $8,000 if you are age 50 or older. A Roth has other restrictions, related to income. For instance:

• A single filer can contribute the full amount only if they make $146,000 or less annually, as of the 2024 tax year. For 2025, they must make $150,000 or less.
• After that, you can invest to a lesser degree, up to an annual income of $161,000 in 2024 and $165,000 in 2025.

Note that the income limits are higher for married couples filing jointly.

As with a 401(k), a Roth IRA has some penalties associated with taking money out before you hit retirement age. But there are a few notable exceptions that may be useful in an emergency. First, you can always withdraw the money you invested (but not the gains it earned) without paying a penalty.

SIMPLE Individual Retirement Account (IRA)

The Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement account available to employees of small businesses. It’s an alternative to the 401(k), which is expensive for an employer to manage. It works the same way a 401(k) does, allowing employees to save money automatically through payroll deductions with the option of an employer match.

This amount is capped at 3% of an employee’s annual salary. The annual contribution limit for a SIMPLE IRA is $16,000 in 2024 and $16,500 in 2025. Catch-up contributions of $3,500 allow employees 50 or older to bump that limit up to $19,500 in 2024 and $20,000 in 2025.

The Bottom Line

Everyone dreams of the day they can finally say goodbye to the workforce. But doing so costs money. That’s where retirement planning comes into play. It doesn’t matter at what point you are in your life. Setting aside money now means you’ll have less to worry about later.

If you need assistance regarding your retirement, CU members have access to FREE financial planning. Daniel Campanelli, CFS, CRPC, CFP has been serving PAFCU members since 1998 using a four-step financial planning process. Customize solutions are based on individual needs, goals and objectives.

This service is always available to our members and their families without any cost or obligation

For more information, please contact Dan at 631-434-3500 x 214 or email at daniel.campanelli@lpl.com.