Why is retirement planning important? The importance of retirement planning is simple:
Proper retirement planning will allow you to decide when work becomes optional for you and how to live your life after you’ve stopped working. Retirement planning allows you to achieve financial security so you have enough money throughout your golden years. Retirement planning can be the difference between a comfortable retirement and being a financial burden.
This guide will help you understand:
- What retirement planning is
- Why retirement planning is important
- Steps you can take today to ensure a financially secure retirement
What is Retirement Planning?
Retirement planning is a fundamental part of the financial planning process. But to understand retirement planning, we have to first understand financial planning.
Financial planning is the the process of determining financial goals so you can develop a plan to achieve financial independence. Financial planning involves:
- Protecting against financial risks
- Properly managing cash flow
- Investing properly to increase wealth over time
Let’s look at each of these risks a little more closely.
Protecting against financial risks
Everyone has some sort of financial risk in their life. People coming out of college usually feel like they don’t have enough money to pay for their student loans. New parents are worried about their ability to raise a family and send their kids to college. Retirees wonder if their money will last as long as they do.
Financial risks are real for everyone. Even people who seem to have more than enough money might be worried that inflation will erode their quality of life over time.
Financial planning helps identify these financial risks so you can address them. For example, someone who is worried about taking care of their family might buy a life insurance policy. Another person with concerns about long-term care might look at insurance products.
Properly managing cash flow
Basic financial literacy involves not spending more than you earn. But how do you do that when there are so many things competing for your money?
And if you have money left over after living expenses, what’s the next step? Do you start an emergency fund? How much money do you put into mutual funds? Do you start a Roth IRA or contribute to your pension plan?
Financial planning helps you to ensure that every dollar goes to the things that are important to you.
Investing properly to increase wealth over time
Let’s imagine that you’ve taken steps to protect against financial risks. You’re properly managing your cash flow. What’s next?
Now you start accumulating wealth. But the important thing is not to just let excess money sit in a savings account, where it does nothing for you. Proper long term investing accounts for:
- What type of investments are right for you
- How much investment return you should expect in the long run
- How much risk you should take for your expected return
Financial planning is important throughout your entire life. Retirement planning helps you focus on transitioning from working life to ensuring your nest egg protects your financial future. Before we discuss retirement planning, we should talk about the difference between plans and planning.
Financial Plans vs. Financial Planning
Here is the difference between a financial plan and financial planning.
Financial plan: A financial plan is a static document. It’s a snapshot in time based on information that you gave to a financial advisor.
A financial plan doesn’t evolve. It doesn’t grow. It just sits there. Does nothing. It’s obsolete from the moment you receive it from the advisor.
Financial planning: Financial planning is an iterative process. You might start with an initial plan that has a lot of mistakes.
But you keep improving on that plan. As your advisor learns more about you, the more you’re able to improve the plan. That plan grows over time, becoming better suited to your needs.
Back to retirement planning. Retirement planning brings the financial planning focus on your career transition.
Here are 9 reasons why retirement planning should be important to you.
9 Reasons Why Retirement Planning is Important
1. You’ll be better prepared for the future.
In the military, there is a saying: “Plans are worthless. But planning is everything.” And they’re right.
Nothing is going to go exactly according to your plan. Odds are that if you hire someone to draft your financial plan, it will be obsolete by the time you bring the plan home.
But you’ll be closer to the right answer than if you did nothing. Even if you only had a plan, with static recommendations, you’d still have something to work with.
But with proper retirement planning, you’ll know what to do when:
- Life changes force an early retirement
- Medical emergencies occur
- The stock market goes down
You’ll also be able to decide:
- The right retirement plan for you
- The best ways to achieve your retirement goals
- How to live a stress-free life
But most importantly, you’ll be able to decide when you don’t have to deal with the hassles of work.
2. You can decide when work becomes optional for you.
Proper retirement planning allows you to visualize the point at which you no longer need to work. Some people might call this retirement age.
But that might not tell the whole story. More and more, people aren’t tired of working–they’re simply tired of having to work.
During the COVID-19 pandemic, many older workers left the workforce. This was to be expected, as the pandemic presented a lot of unnecessary risks for people who didn’t need the additional income.
Part of this might because some people will need to keep working simply to pay their bills. But many senior citizens take on volunteer work, or low-paying jobs that keep them active.
And if you have an eye on your retirement planning, you’ll be able to decide for yourself. And your body will thank you for it.
3. You’ll enjoy better health.
Health is one of the biggest concerns for retired people. But there is a correlation between good financial health and good health.
According to a 2020 study conducted by the National Institutes of Health, “financial health can be conceived of and measured as a key social determinant of health.” In other words, the healthier your finances, the healthier you’ll probably be.
And the healthier you are, the more you can live your best life.
4. You can live your best life.
To-do list. Bucket list. Whatever you call it, there are certain things that you want to do while you’re on this Earth.
Odds are, you’re not doing it right now. You’re too busy. Or you’re too stressed. Perhaps you’re worried about the future.
Whatever it is, there is something that’s blocking you from living your best life. If that’s the case now, what do you expect your retirement years to look like?
By taking the proper retirement planning steps, you can stop asking those questions and start answering them. And the sooner you answer those questions, the sooner you can get back to living your best life.
And with the average life expectancy on the rise, you’ll be able to enjoy it longer. Independently.
5. You won’t have to depend on your family to support you.
According to a recent Forbes article, 30% of adults with a parent age 65 or older provides reported that their parent requires financial assistance. And an AARP survey states that nearly one-third of middle-age adults with at least one living parent provides financial support.
Related to the financial stress of caring for an aging parent is the emotional toll. “Caregiver stress” is a real phenomenon, and it’s on the rise. Additionally, studies show a link between caregiver stress and increased anxiety in family carers.
Having a secure retirement fund will help ensure that your family members don’t have the added financial stress of supporting you. And having a good retirement plan before you stop working will ensure that you do just that.
6. Your family will appreciate you more.
On the flip side, if you’re not a burden to your adult children, then they’ll want to spend more time with you.
Those family vacations? They’re a lot more fun when you’re able to pay your way. It’s even more fun when you’re able to spoil your grandkids and watch them grow up.
There’s wrong with having a retirement lifestyle that lets your family bonds get stronger. And the best retirement plans will help your money keep up with inflation.
7. Your money will keep up with the cost of living.
In retirement, you’re responsible for your own cash flow. This can be from money you’ve accumulated. It can also be from other sources of regular income, like Social Security benefits.
Some income sources, like Social Security benefits and certain pensions, have cost of living adjustments (COLAs), that keep up with inflation over time.
But proper retirement planning doesn’t just depend on Social Security or pensions. The right retirement plans can help your nest egg grow over time, beating inflation.
And with proper planning, you’ll pay less income tax.
8. You’ll give less money to the government.
Tax planning is another vital component of financial planning. And since proper financial planning leads to proper retirement planning, you could say that tax planning is a big part of that. Paying less tax, but accomplishing the same thing, is known as tax efficiency.
And if you start retirement planning early enough, you’ll see tax efficiency everywhere. And along the way, that will help you answer some of the following questions:
- Am I better off starting a traditional IRA (individual retirement account) or a Roth?
- What are the tax benefits of my workplace contribution plans?
- Is it a good idea to take my pension in a lump sum?
- What are the most tax-efficient retirement investments?
By thinking about your retirement planning, you’ll naturally start asking tax-related questions. And by answering those tax questions, you’ll be that much better off. And you can keep your money for the important things.
9. More of your money will go to what’s important.
One thing people struggle with in retirement is figuring out what to do. Sometimes, it’s because they’re having to settle for something less than what they wanted.
But under the right financial circumstances, more of those opportunities open up for you. And the most successful retirees find that they have more than they need, so they decide to give some of it away.
But the distinction is this:
Proper retirement planning will allow you to decide where your money goes.
Lack of proper retirement planning means that your options will be limited.
Now that we’ve stressed the importance of proper planning, let’s look at some of the big-picture questions that you’ll be able to answer.
11 Questions That Proper Retirement Planning Will Help You Answer
1. Should I do Roth conversions?
When I was a financial planner, clients used to ask this question all the time!
Since each person’s tax situation is different, the answer is, “it depends!” But with a proper eye on tax efficiency, retirement income goals, and investment objectives, you can craft a Roth conversion strategy that works for you.
2. When should I take Social Security?
You can take Social Security as early as age 62. Or you can delay until age 70, where your retirement benefits will be much larger. Or you can do something in between.
According to the Social Security Administration, starting Social Security at age 62 can reduce benefits by as much as 30 percent. That’s a decision worth thinking through.
Sometimes people take early Social Security is to pay for post-retirement living expenses. One of the biggest examples is medical expenses.
3. How do I pay my medical expenses?
Once you’re old enough to qualify for Medicare, paying medical expenses becomes a little easier. You know your premiums, deductibles, and out of pocket medical costs. Perhaps the biggest challenge is figuring out what type of Medicare supplemental plan you should have.
But what if you’ve retired before qualifying for Medicare? What do you do? Proper retirement planning will help you answer that question before you stop working.
4. How should I invest?
Should I buy index funds? What type of mutual funds should I have in my retirement savings plan? Should I invest in real estate?
It’s hard to develop an investment philosophy when you’re not clear on your retirement income goals. That’s like flying a plane as fast as possible and trying to figure out where you’re going after you started.
By thinking about your retirement goals, you can be clear about your investing goals. And once you understand your investing goals, a good financial planner can help you decide what investments you should have.
5. How much income should I expect from my investments?
Perhaps a better question would be, “How much cash flow do I need?”
After a lifetime of managing paycheck to paycheck, cash flow is one of retirement’s biggest concerns. And after retirement, it’s easy to assume that you have to replace cash flow with investment income. But that’s not necessarily true.
One of the first things that financial planners do is help people manage their cash flow. Not only does this immediately reduce anxiety, it helps set the state for the more complex planning.
But that begs the question.
6. What are my retirement income goals?
How much income should I be able to expect? How will that affect my wealth over time?
Retirement is a long time. If you retire at a young age, you could spend 40 or 50 years in retirement. You should reasonably expect to earn some money during that time.
Proper retirement planning will enable you to understand what your goals should be. That way, your cash flow becomes more clear.
Because when people no longer worry about their sources of income, they can devote their attention to some of the other financial planning priorities. Like estate planning.
7. What does estate planning look like?
What is estate planning? Simply put, it’s thinking about what’s going to happen to you, your loved ones, and your assets when you’re no longer able to decide for yourself.
It’s hard to think of all the different risks in your life. And it’s hard to think about those situations where things are happening that you have no control over.
And that’s why estate planning is so important. As part of the retirement planning process, you’ll be thinking through some of the answers to these questions. That way, when the time comes (hopefully it doesn’t), your wishes are known.
8. How can I contribute to charity?
Sometimes, you do so well in retirement that you have more money than you can spend (reasonably) in your lifetime. Since you can’t take it with you, what can you do it?
Many people choose to give their money to loved ones. And some people choose to support charitable causes that are important to them.
Fortunately, the United States government tries to incentivize charitable giving. And one way they do that is by giving tax breaks to donors.
9. What are the tax advantages of contributing to charity?
According to the IRS, over 4.2 million taxpayers donated over $116 billion in non-cash charitable contributions in 2018. And that doesn’t even cover the amount of checks & cash that is donated but not reported to the IRS.
Needless to say, there are plenty of opportunities to contribute to charity. With an eye towards tax-efficiency, those donations can go even further. But that’s just one way to keep your taxes low.
10. How can I lower my taxable income?
Old: “Can I take a tax deduction for this?”
New: “How can I do this while paying the least amount in taxes?”
In other words, you shouldn’t be so focused on on taxes that the tail wags the dog. But you should be able to ask the right questions so you can do what you want while keeping your tax liability as low as possible.
Which means more of your money stays in your pocket, just in case.
11. What life events do I need to be prepared for?
Who knows what the future holds? But the older we get, the more our longevity risk goes up.
Which means we should be prepared for things that might happen. And a proper retirement plan will account for those things.
3 Retirement Planning Steps You Can Take Today!
Of course, you might have questions besides the one on this list. Regardless, it’s a daunting task.
Fortunately, there are quick and simple steps that you can take right now towards a more secure financial future. Here are three of them.
1. Save 10% of your income. Always. More if you can.
The first step is to stop spending more than you’re earning. Save the difference.
If you aren’t already doing so already, there are several benefits to living beneath your means.
- You can start accumulating the extra money elsewhere. Start a rainy day fund. Increase your 401k contributions. Start that IRA.
- If you can live off 90% of what you earn, then a 10% pay cut won’t hurt you as bad. What happens when the stock market goes down? What if there are temporary layoffs? Having that buffer will keep you a little more secure. And people who are financially secure can ride out the bad times a lot better.
2. Pay off all bad debt. Keep it paid off.
If you have a mortgage, that’s great. If you have student loans, that’s fine.
Everything else should be carefully considered. Perhaps you got a 0% loan for those home appliances. Maybe you got a really great deal on your car.
It’s all still bad debt. The interest rate doesn’t matter. What the loan bought does. And if the loan bought a depreciating asset, like a car or appliances, then you need to pay it off as quickly as possible.
And make your future purchases in cash.
Items 1 and 2 checked off your list? Then you’re ready for #3.
3. Hire a team of professionals to help you.
Perhaps you want to do everything yourself. But here’s a list of people who can help you with some of them. Especially the things where you don’t have the expertise or experience:
This can be a Certified Public Accountant or enrolled agent. Even if your tax situation is straightforward, your tax professional can help you stay on top of the latest changes in the tax law.
Need those estate planning documents drafted up? Your estate attorney is going to do that for you.
More importantly, they’re going to be the person that files the required paperwork when your family members have to step in and take control.
A good financial planner can be the person who helps you hold everything together. Most likely, you’ll be talking with your financial planner more frequently than your tax professional or estate attorney.
And a Certified Financial Planner has experience in all of the major financial planning topics. They’re required to have education in the following:
In other words, everything we just discussed. Many people see their financial planner as the ‘glue that holds it all together.’ Often, the financial planner is the first resort for questions when life events happen.
Retirement planning can be a daunting task. But the good news is that it’s never too late to take steps towards a more secure financial future. And the best time to start is now.