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The Basics of Retirement Plans

Will you have the peace of mind to enjoy a dance?  

The best retirement plans are the result of a lot of thought, consulting, and homework. Without a solid plan in place, many people's "golden" years are anything but.

In 2013, Fidelity and Vanguard put out a paper showing that the average baby boomer has just $126,900 saved in 401(k)s. Though Social Security will add to that, those two sources of income combined won't be nearly enough for the average American to live comfortably in retirement.

Indeed, one of the greatest shortcomings of the American public is our inability to plan for the years after we leave the workforce. Though there is no one-size-fits-all plan to solve this problem, there are some general principles that can guide you toward a more financially secure retirement.

A brief history of retirement plans

One of the most important things to acknowledge is that we aren't hardwired to plan a half-century into the future. In our hunter-gatherer days, the tribe provided cradle-to-grave security -- no retirement planning necessary.

Further, according to a study by Merrill Lynch and Age Wave, it wasn't until the 1950s that the average retirement age surpassed average life expectancy. Most people simply didn't live long enough to retire.

Over the past century, retirement planning has gone through several evolutions. First came Social Security, which remains more important to retirees than most realize. In fact, only 10% of retired people have more money in hard assets than they do in terms of guaranteed Social Security income.

Next came defined-benefit plans, or pensions. Typically, these are funded by companies and guarantee a certain amount of income from retirement until death. Though defined-benefit plans were the only retirement plan available to 60% of private-sector employees in the 1980s, they are much less commonplace today.

In their place came defined-contribution plans, which usually take the form of 401(k)s or 403(b)s. Companies set up these accounts and deduct a certain amount from the employee's paycheck to be invested for retirement.

Individuals can also put money away in personal retirement accounts such as Traditional or Roth IRAs. Beyond that, it's not uncommon for people to use life insurance, home equity, and personal savings to help supplement retirement income.

How many retirement plans are there?

This is where things can get confusing. There are as many smart, healthy, financially sound retirement plans as there are folks heading into retirement.

The list of variables that determine what the "best" retirement plan is for you is endless, but the primary considerations include how much money you need to maintain your lifestyle, what your health care needs are, how much you wish to leave to your family, and at what age you wish to stop working full-time.

Some of the most popular investment vehicles for retirement planning are target-date funds, which rebalance their holdings as your desired retirement date approaches. Usually, this means shifting over time from a somewhat aggressive investing style to a more conservative approach.

The plans are so popular that experts believe that by 2020, almost $3.9 trillion in defined contributions -- half of all defined-contribution cash -- will be in target-date funds.

With over 600 different types of target-date funds available, the most important variable to watch is the expense ratio. This represents how much you are paying each year to have your money managed for you. Morningstar reports that the average expense ratio for a target date fund is 1.09%. However, Vanguard, which typically offers the lowest fees in the industry, has target date funds with expense ratios averaging just 0.17%. 

Why use a retirement plan?

This article can't even scratch the retirement planning surface. There are simply too many options out there. That's why hiring a licensed, fee-only professional to help tailor a retirement plan that makes sense to you is so important.

The benefits of doing so are clear. The Social Security Administration's most recent report predicts that benefits will be cut 23% by 2034. Pensions and other defined-benefit plans are going the way of the dodo bird. If you want to have a secure and comfortable retirement, the only person you can count on to look after your future is you.

The bottom line on the best retirement plans

Remember, the basics can go a long way toward making the retirement planning process easier. Start as early in your life as you can, spend less than you earn, and invest the difference. Wash, rinse, and repeat. Hire someone you trust to help you navigate the process.

Follow those simple steps, and you'll be saving yourself from both headaches and heartaches down the road.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it’s not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.

Read/Post Comments (3) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 11, 2014, at 4:58 PM, pete163 wrote:

    I'm working on my retirement right now I picked up a load of BAC knowing it's going up with a good dividend that will soon go up as well.

  • Report this Comment On August 14, 2014, at 3:27 PM, KayakerRW wrote:

    “In 2013, Fidelity and Vanguard put out a paper showing that the average baby boomer has just $126,900 saved in 401(k)s.”

    Did they also look at how much was in IRA’s?

    I have a good pension plan at my job, but the 401(K) plans were all up front load mutual funds with high fees and no employer match, so eventually I stopped contributing to those, but fully contributed to a regular IRA and a Roth IRA. I also have money in taxable accounts that I will use for retirement, because even with taxes, the returns are better than the 401(K) plan with a 5% load and high fees.

    I don’t know how many other people are in similar situations, but this does illustrate that there are people with more money saved for retirement than a single statistic (money in 401(K)’s) reveals.

  • Report this Comment On August 18, 2014, at 8:56 AM, pete163 wrote:

    I agree with KayakerRW plus a lot of the baby boomers have also done a force payoff on there homes and credit cards. To cut cost down the road. At least some of the baby boomers are trying to do something. Plus buying stocks in the big banks are cheap right now. It will help with recouping some of the loses that hit in 2008.

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Brian Stoffel

Brian Stoffel has been a Fool since 2008, and a financial journalist for the Motley Fool since 2010. He tends to follow the investment strategies of Fool-founder David Gardner, looking for the most innovative companies driving positive change for the future.

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