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Retirement planning can be an overwhelming endeavor, but it’s critical to ensure that your financial needs are met once you’re no longer working. Here’s what you need to know about retirement planning including key steps in the process and some of the top retirement plans to consider.

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What is retirement planning and why is it important?

Retirement planning involves estimating the amount of money you’ll need in retirement and saving and investing in order to achieve that goal. Many people don’t start thinking about retirement until they’re in their 40s or 50s, but waiting until then to start saving and investing will put you at a major disadvantage.

Retirement needs will vary from person to person, but most people will need a significant sum of money in order to live comfortably during their golden years. Experts often recommend saving enough to replace about 80 percent of your current income, which for some people will mean saving $1 million or more. While saving this amount of money can seem daunting, planning for it early in your career will make it more likely that you’ll reach your goal.

Retirement planning: Key steps

Retirement planning is an ongoing process that will need to be updated as your plans for the future change. Here are the key steps to retirement planning.

1. Estimate how much money you’ll need to retire

How much you’ll need to retire depends on how much you’ll spend during retirement. You’ll want to think about key questions such as whether your house will be paid off or not, the state you plan to live in and the type of lifestyle you want to live.

Financial advisors often suggest replacing about 80 percent of your current income during retirement, but the exact amount depends on your estimated expenses. Managing healthcare costs during retirement is often overlooked, but these expenses can be a major factor as people age. Be sure to consider all expenses when determining how much you’ll need to retire.

2. Determine how much to save each month and which accounts to use

Once you have an estimated amount you’ll need to retire, you can work backwards to determine how much you’ll need to set aside each month. You’ll also want to factor in an expected investment return over the time you’re saving for retirement. Estimating a 6-8 percent return is a reasonable assumption, but your actual return will depend on your asset allocation, as well as other factors.

There are several retirement accounts that come with tax advantages. Making regular contributions is made simple through employer-sponsored plans such as a 401(k), and you may even get a matching contribution, which is like free money. You can also set up additional retirement accounts such as a traditional or Roth IRA.

3. Choose investments

Once you’ve started saving and selected which accounts to use, you’ll need to choose how to invest the money. Many investors choose stocks because they’ll have time to recover from any short-term losses. Over the long term, stocks have returned around 10 percent annually.

As you get closer to retirement age, you’ll likely shift your portfolio more towards fixed income investments such as bonds. These investments provide regular income and are less volatile than stocks, making them solid picks as you get closer to your investment goal.

Many investors use mutual funds and exchange-traded funds (ETFs) to save for retirement. These funds often invest in hundreds of different stocks and bonds, allowing you to build a diversified portfolio at a low cost. Diversification is key when building an investment portfolio and can protect you from sudden changes in the stock market.

4. Periodically review investments and retirement plan

You’ll want to review your investments at least a few times each year and reassess your retirement priorities. You’ll want to adjust your savings or investments if you’ve changed your ultimate retirement goal.

It may also make sense to rebalance your investment portfolio if allocations have shifted due to market performance. If one investment has outperformed others, it may account for a larger portion of your portfolio than you want.

Top retirement plans

Employer-sponsored plans

One of the easiest ways to get started with saving for retirement is through an employer-sponsored plan such as a 401(k) or 403(b). These plans make it easy to make regular contributions from your paycheck towards your retirement savings and typically come with low-cost investment funds to choose from. You won’t have to worry about paying taxes on any gains until you start making withdrawals during retirement and you’ll get a tax break on your contributions. If you choose a Roth 401(k) plan, you’ll contribute money on an after-tax basis, but won’t pay taxes on withdrawals during retirement.

You may also get an employer match, where your employer contributes a certain percentage of your contribution amount, up to a limit. For example, your employer may match up to 3 percent of your income, which means if you contribute 3 percent of your earnings, your employer will also contribute 3 percent, for a total of 6 percent. This is like free money, so you’ll want to contribute enough money to at least take advantage of the match.

Individual plans

You can also open individual retirement accounts as an additional way to boost your savings. These accounts come with lower contribution limits than employer-sponsored plans, but you will have a lot more investment options to choose from.

  • Traditional IRA: A traditional IRA allows you to make pre-tax contributions to a retirement account, where your money can grow tax-deferred until you start making withdrawals during retirement.
  • Roth IRA: A Roth IRA is funded using after-tax money, so you won’t get a tax break today, but withdrawals during retirement are tax free. A Roth IRA is a great way to save if you think your tax rate will be higher during retirement than it is today.

How to invest for retirement

You’ll have several options when it comes to choosing investments for your retirement portfolio. Here are some of the most popular choices:

  • Stocks: Stocks represent an ownership stake in a business. You can own individual stocks in retirement accounts, but most people own stocks through diversified mutual funds or ETFs. Stocks can be volatile in the short term, but broad stock market indexes such as the S&P 500 have performed well over time.
  • Bonds: Bonds are less volatile than stocks and can help generate income during retirement. Most investors shift their portfolios towards bonds as they get closer to retirement age to reduce the risk that comes with owning a stock-heavy portfolio.
  • Mutual funds: Mutual funds are a great way to invest in baskets of stocks and bonds because they allow you to build a diversified portfolio at a low cost. You can invest in stock funds and bond funds, as well as balanced funds that hold a combination of both assets.
  • ETFs: ETFs are similar to mutual funds, but they typically come with lower investment minimums and trade throughout the day similar to stocks. Pay attention to a fund’s expense ratio before investing. These are fees and come directly out of the return you’ll earn, so it’s important to keep them as low as possible.

Bottom line

Retirement planning is a process everyone should go through as soon as possible to make sure they’re on track to meet their goals. Work backwards from where you want to be and how you want to live during retirement to determine what you need to be saving today. Be sure to make the most of tax-advantaged retirement accounts and choose investments that reflect your risk profile and ultimate goals.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.