Learn About Retirement Planning Options and Strategies

Understanding the Basics of Retirement Planning

Retirement planning is the process of setting financial goals for the years when you stop working and figuring out how to pay for living expenses during that time. According to the U.S. Census Bureau, about 56 million Americans were age 65 and older in 2020, and that number continues to grow. Many of these people rely on a combination of savings, Social Security, pensions, and other income sources to cover their expenses.

The foundation of retirement planning starts with understanding what you'll need. Most financial professionals suggest that you'll need about 70 to 80 percent of your pre-retirement income to maintain your current lifestyle in retirement. This is because certain expenses, like commuting costs and work-related expenses, disappear. However, healthcare costs often increase as you age, which can offset some savings.

Starting to think about retirement in your 20s or 30s gives you decades to save and invest. Even small amounts saved regularly can grow significantly over time through the power of compound growth. For example, if you save $200 per month starting at age 25, you could accumulate approximately $200,000 by age 65, assuming an average annual return of 7 percent. Starting at age 35 with the same monthly savings would result in roughly $110,000 by age 65.

Understanding the timeline for retirement is also important. The full retirement age for receiving full Social Security benefits ranges from 65 to 67, depending on your birth year. However, you can claim benefits as early as age 62, though the monthly amount will be permanently reduced. Conversely, if you delay claiming until age 70, your monthly benefit increases significantly—by about 8 percent for each year you wait past your full retirement age.

Practical Takeaway: Calculate a rough estimate of your retirement expenses by adding up your current yearly spending and subtracting costs that will disappear after retirement (like work commute expenses). Multiply this number by 25 to get a rough target for total retirement savings, using the general rule that you can withdraw about 4 percent of your savings annually.

Employer-Sponsored Retirement Plans: 401(k) and 403(b)

A 401(k) is a retirement savings plan offered by many employers. The name comes from the section of the Internal Revenue Code that created it. With a 401(k), employees can contribute a portion of their salary directly from their paycheck, before taxes are taken out in many cases. This means your contributions reduce your current taxable income, which can lower the amount of income tax you owe each year. For 2024, employees can contribute up to $23,500 per year to a 401(k), and those age 50 and older can contribute an additional $7,500 as a "catch-up" contribution.

Many employers offer matching contributions, which means they contribute money to your 401(k) based on how much you contribute. A common match is 50 cents for every dollar you contribute, up to 6 percent of your salary. For example, if you earn $50,000 and contribute $3,000 (6 percent), your employer might add $1,500. This is essentially free money toward your retirement. The Society for Human Resource Management found that about 77 percent of employers with 401(k) plans offer some form of matching.

A 403(b) plan is similar to a 401(k) but is offered by nonprofit organizations, public schools, and certain government agencies instead of private companies. The contribution limits and rules are essentially the same as a 401(k). Both plans allow your money to grow tax-deferred, meaning you don't pay taxes on investment earnings until you withdraw the money in retirement.

One important consideration is whether your plan is traditional or Roth. With a traditional 401(k), contributions are made with pre-tax money, reducing your current taxes but requiring you to pay taxes on withdrawals in retirement. With a Roth 401(k), contributions are made with after-tax money, but qualified withdrawals in retirement are tax-free. Some employers offer both options, allowing you to split your contributions between them.

Practical Takeaway: If your employer offers a 401(k) or 403(b) with matching contributions, aim to contribute at least enough to receive the full match—this is an immediate return on your money. If you can't contribute that much right now, increase your contribution by 1 percent of your salary each year until you reach the match level.

Individual Retirement Accounts (IRAs): Traditional and Roth

An Individual Retirement Account, or IRA, is a retirement savings account that you open on your own, rather than through an employer. IRAs have significant tax advantages and are available to anyone with earned income. In 2024, you can contribute up to $7,000 per year to an IRA, or $8,000 if you're age 50 or older. Even if you have access to an employer plan at work, you may also open and contribute to an IRA.

A Traditional IRA works similarly to a traditional 401(k). Your contributions may be tax-deductible depending on your income and whether you have access to other retirement plans at work. Your money grows tax-deferred, and you pay taxes on withdrawals in retirement. You must begin taking required minimum distributions (RMDs) starting at age 73, as of 2023. These distributions are taxable income. The advantage of a Traditional IRA is the immediate tax deduction, which can lower your current tax bill.

A Roth IRA operates differently. Contributions are made with after-tax money and are not tax-deductible. However, your money grows tax-free, and you can withdraw your earnings tax-free in retirement, provided you've had the account open for at least five years and you're at least 59½ years old. Additionally, there are no required minimum distributions during your lifetime with a Roth IRA, which can be valuable if you don't need the money immediately. Roth IRAs also allow you to withdraw your contributions (not earnings) at any time without penalty, providing some flexibility. However, Roth IRA contribution limits are reduced or eliminated if your income exceeds certain thresholds. In 2024, the limits begin to phase out at $146,000 of modified adjusted gross income for single filers.

The choice between Traditional and Roth depends on your current tax bracket and expectations about your tax bracket in retirement. If you expect to be in a lower tax bracket in retirement, a Traditional IRA may be advantageous. If you expect to be in the same or higher tax bracket, a Roth may be better. Many financial advisors suggest contributing to both types if your income allows, to provide tax diversification in retirement.

Practical Takeaway: If you're self-employed or don't have access to an employer retirement plan, open an IRA. If you have both a 401(k) at work and want additional retirement savings, consider a Roth IRA for tax-free growth. Compare your expected current tax rate to your expected retirement tax rate when deciding between Traditional and Roth options.

Social Security and How It Fits Into Retirement Income

Social Security is a federal insurance program that provides income to retired workers, disabled individuals, and survivors of deceased workers. It is funded through payroll taxes—both employees and employers contribute 6.2 percent of wages, up to a maximum amount set annually. According to the Social Security Administration, about 67 million people received Social Security benefits in 2023, with an average monthly benefit of $1,827 for retired workers.

Social Security is based on your earnings history. The program calculates your benefit using your 35 highest-earning years of work. If you have fewer than 35 years of earnings, zeros are included in the calculation, which reduces your average. To receive benefits, you need to have earned at least 40 work credits, which is roughly equivalent to 10 years of work. You can create a "my Social Security" account online at ssa.gov to view your earnings history and projected benefits.

The age at which you claim Social Security significantly affects your monthly benefit amount. Your full retirement age—the age at which you receive 100 percent of your calculated benefit—depends on your birth year. For those born in 1943 or later, the full retirement age ranges from 66 to 67. If you claim at 62, your benefit is reduced by about 30 percent. If you delay claiming until