Leave your retirement to chance and you may end up living in a van down by the river -- or in circumstances you don't like. Spend a little time thinking about retirement and taking some action, though, and you may be able to pass your golden years in comfort, with few financial worries. Here are three retirement planning rules everyone should follow.
1. Don't wait another week
For starters, begin dealing with your retirement planning now, even if you're just in your 20s or 30s. Do some research, calculate how much money you think you'll need for the senior lifestyle you want, and devise a plan for how you'll accumulate the needed sum.
If you're still early in your career, it can feel reasonable to postpone thinking about the topic of retirement for another decade or two, but you'll short-change yourself that way. That's because you'll be wasting the enormous power of compounded growth. If you're 35, you have a full 30 years until you reach the common retirement age of 65. Investing just $5,000 annually for 30 years will leave you with more than $600,000 if it grows at an average annual rate of 8% -- and more than $900,000 if it averages 10% growth. If those investments were in a Roth IRA, all that money would be available to you tax-free, too! (Obviously, if you save more than $5,000 in many years, you can accumulate much more -- or perhaps retire much earlier.)
If you're 55, you can still improve your financial future, but it will be harder, as you have less time in which your money can grow. Socking away $5,000 annually will grow your account to around $78,000 if it grows at an average of 8%. Contributing four times as much -- $20,000 -- each year for a decade will get you to just above $300,000. That's a substantial sum, but it's far less than the $600,000 you'd have wound up with by making smaller monthly contributions over a 30-year period.
Make use of the tax-advantaged retirement accounts available to you, such as traditional and Roth IRAs, and traditional and Roth 401(k) plans offered by your employers. Also, try to avoid cashing out 401(k) accounts when you change jobs. You'll be better served by either rolling them into your new employer's 401(k) or an IRA, or leaving them alone to grow. Likewise, try not to borrow funds from those retirement accounts if you can avoid doing so.
2. Use the 4% rule as a starting point
It can be hard to estimate how much you'll need in retirement, so you might want to employ the 4% Rule. This is a commonly suggested guideline that when it comes time to stop adding your stock-and-bond nest egg and start using it to fund your retirement, you should plan to withdraw 4% of your portfolio's value each year. Drawing down on the balance at that rate, your money should last about 30 years. (Some financial advisers suggest using a 3.5% withdrawal to be more conservative.) It's an imperfect rule, but starting with it can still help you calculate backwards to get to the ballpark of what you need.
Here's how you might use it: Imagine that you are aiming for annual income of $45,000 in retirement, and you expect $25,000 to come from Social Security benefits. That means you'll need to generate $20,000 on your own. How big a nest egg will generate that income? Well, dust off the 4% rule. Invert the 4% and you'll get 25 (100 divided by 4% is 25). Multiply $20,000 by 25 and you'll arrive at $500,000 -- the size of the nest egg you'll need if you want to apply the 4% rule. If you plan to use a more conservative 3.5% withdrawal, multiply the $20,000 by 28.6, and you'll arrive at a goal of $572,000.
3. Plan in more than a financial way
Keep in mind, too, that retirement planning should involve more than just money. Yes, you should make an effort to accumulate as much as you'll need, but keep the other aspects of your life in mind, too. Be sure to include healthcare expenses in your retirement plans. (The folks at Fidelity have estimated that a 65-year-old couple will spend, on average, around $260,000 out of pocket on healthcare over the course of their retirement.) But also think about how you will get and/or stay healthy in the years leading up to and during your retirement. The healthier you are, the more likely you'll be to need less care in retirement, keeping costs down and comfort up.
Think about how you'll spend your days, and consider whether you might end up bored or feeling aimless -- something that happens to many retirees. You might have a few Plan Bs in mind, such as volunteering activities you could sign up for, places where you might enjoy a part-time job, or new hobbies or interests to pursue. Think about whether you want to downsize into a smaller home or move to a less expensive region -- or closer to loved ones.
The more you think about and plan for your retirement, and the further in advance of it you start, the better it's likely to be.