What is Retirement Planning?
Retirement Planning Definition
Retirement planning is the process of saving and investing money before retirement in order to ensure a source of income after retirement.
Most often this is done using financial vehicles designed specifically for this purpose, such as an IRA or 401(k).
The funds placed into the account are invested and grow over the course of the account holder’s life.
Usually the accounts do not allow the account holder to access the funds until a prerequisite age.
Once the account holder reaches that age, the accumulated funds are distributed back to them.
This can be in several payments or a lump sum.
Retirement planning often encompasses more than simply choosing a few investments and waiting for your money to grow.
It’s important from the outset to have an idea about the time horizon you expect, your risk tolerance, and most importantly, your financial goals for retirement (do you need money to travel? Want to buy a summer home? Or just looking to settle down?).
Although no one likes to think about it, it’s also a good idea to plan for what will happen in case you happen to pass on with funds still remaining in your account.
Many retirement accounts can be transferred to a next of kin, but it is important to make sure.
The age at which you plan to retire is also an important consideration.
The earliest that 401(k)s and IRAs begin distributions is age 59 ½, and the latest is age 70 ½, so if you plan on retiring earlier or working for longer that should be planned for.
Types of Retirement Plans
IRA and 401(k):
An IRA, or Individual Retirement Account, is a retirement account that is owned and managed by you, for you, although there are professional managers available as well.
A 401(k) is a retirement account that is (most commonly) sponsored by your employer rather than yourself.
Funds are contributed as an amount of withheld salary, and your employer may make additional contributions as well.
Both an IRA and a 401(k) are funded with pre-tax dollars.
This means that contributions reduce taxable income in the year they are made, and the taxes are paid later upon withdrawal.
As such, these retirement vehicles are the most beneficial when you expect that you will be in a lower tax bracket upon retirement than you are while funding the account.
Roth IRA and 401(k):
Roth IRAs and 401(k) are similar to their traditional counterparts, however taxes are paid on contributions, and the money is distributed tax free upon retirement.
This type of pan is ideal if you expect to be in a higher tax bracket upon retirement than while you own the account.
Pension/Defined Benefit Plan:
A pension, also called a defined benefit plan, is one of the most traditional forms of retirement package.
Typically it is given by an employer to a retiring employee, and is based on factors such as the amount of time worked.
This retirement package is a set amount of money and is not based on investments.
Profit Sharing Plan:
Profit sharing is an additional feature that may be added to another employer sponsored plan.
Profit sharing allows an employer to make contributions to an employee’s account up to the lesser of 25% of income or $57,000.
The idea is that as a company’s profits increase, profit sharing allows employers to distribute a portion of profits back to employees.
Employee Stock Ownership Options (ESOP):
Employee Stock Ownership Options, or ESOP, allows employees to benefit from ownership of company stock.
This may be given in addition to another retirement plan.
Types of retirement investments include:
- CDs (Certificates of Deposit)
- Real estate
Generally an IRA will offer a more diverse selection of investments.
A 401(k) or other employer sponsored plan may limit you to only investments that your employer has picked out.