What does retirement look like for you?

Retirement is a goal many aspire to achieve, yet it holds different meanings for different people. For some, it signifies a transition into a life of leisure with no work obligations, offering complete relaxation. For others, retirement means having the liberty to live without the necessity of work, while also having the flexibility to pursue new ventures, such as launching a business or dedicating time to volunteer work.

However you define retirement, the process to get there is relatively the same.

Beginning with an understanding of retirement planning is crucial. Consider it as budgeting for the future. Start with your desired outcome and plan backwards from there. Numerous tools are available to assist you on this journey, but it is advisable to consult with a trusted advisor for guidance.

In this exercise, you will envision your retirement lifestyle and calculate its total cost. A key factor is inflation. The cost of a Hawaiian vacation today will not be the same in 20 years. Additionally, you should decide on your preferred retirement age and the duration of retirement, typically using the average mortality table to ascertain this number. This approach will yield the total sum required at the start of your retirement.

Subsequently, you should calculate the monthly or annual savings required to accumulate your target sum by the first day of retirement. It is advisable to view this as a monthly contribution to ensure consistent progress.

Next, you'll need to decide which savings vehicles to utilize for your contributions. Options include a 401k, IRA, taxable brokerage account, or a mix of these. Each choice offers its own benefits, and it's often wise to diversify by having a combination.

Finally, investment decisions are crucial. This is the stage where you decide on the investment strategy for the funds within the aforementioned account types. The way you invest will greatly influence your success in reaching your retirement goals from day one. This applies to contributions made both before and after retirement. Investment strategies typically vary between the pre-retirement and post-retirement periods. It's common to adopt a more aggressive approach in the years leading up to retirement and become more conservative after retiring.

Let's talk about the different types of retirement accounts.

401k/403b

These retirement plans, often sponsored by employers or government agencies, offer a convenient way to allocate a portion of your paycheck directly into the plan. This "out of sight, out of mind" approach can be an effective strategy for consistent contributions.

Regarded as qualified plans, the contributions made can grow tax-deferred until withdrawal. However, preferential tax treatment stipulates that funds cannot be withdrawn without penalty before the age of 59 1/2, with few exceptions.

Many plans also feature employer contributions, commonly in the form of a match, which is essentially free money that should not be overlooked. Details about this can typically be found in your benefits information.

Another benefit is that contributions are made pre-tax, reducing taxable income. For instance, if your salary is $1,000 and you contribute 10%, taxes would only apply to $900.

With the combination of tax benefits and employer matching, these plans are an excellent choice for retirement savings.

Traditional IRA

This plan is also qualified and operates similarly to a 401k/403b. The primary difference is that it's established by the individual, not the employer. It offers the same tax benefits, except the contribution limits are lower ($7,000 for 2024) compared to a 401k ($23,000). Contributions are deductible and grow tax-deferred until withdrawal. The same age restriction of 59 1/2 years applies.

A traditional IRA is an excellent choice for those without employer-sponsored 401k access. It is particularly beneficial for individuals in their peak earning years due to the tax deduction advantage.

ROTH IRA

Not everyone is eligible to contribute to certain types of retirement accounts due to income limitations, which may restrict participation in a ROTH IRA. Contributions to a ROTH IRA are made with after-tax dollars, meaning there's no immediate tax deduction. However, the growth is tax-deferred, and future distributions are tax-free, making it a potent tool for retirement planning. While the future tax landscape is uncertain, current rates are known, and contributing to a ROTH allows for paying taxes now to avoid concerns about future rates. ROTH IRAs require that distributions start at the age of 59 1/2 to avoid penalties.

A ROTH IRA is an excellent choice for those in the early stages of wealth accumulation. Typically, the immediate tax deduction is not necessary, and one may qualify for a ROTH IRA based on a lower income. It's also ideal for those seeking certainty in their tax obligations. Converting a traditional IRA to a ROTH IRA involves paying taxes now rather than later, which can be advantageous in years when income is significantly reduced. By converting, you can pay taxes at a lower rate today and benefit from tax-free growth in the future.

ROTH 401k

An increasing number of companies are including this choice in their retirement benefits. It's an excellent option as there are no income restrictions for contributions. You can contribute up to the same amount as a traditional 401k, which is $23,000. Additionally, all the benefits associated with a ROTH IRA are applicable to a ROTH 401k as well.

Taxable Accounts

Utilizing a taxable account for retirement savings is always an option, though it lacks the tax benefits of the retirement accounts previously mentioned. However, it does offer greater flexibility should you need to access the funds later, without incurring a 10% penalty. Additionally, these accounts can offer tax advantages for retirement due to capital gains tax rates, which are typically lower than regular income tax rates for those earning more than $44,725 annually.

Despite the variety of choices, consulting with a financial planner to determine the most suitable option or combination for your individual circumstances is advisable.