Strategic Retirement Planning: A Guide to Early Financial Preparation

Introduction: Living Longer and Planning Ahead

People are living longer and enjoying better health than ever before. As one retirement researcher notes, "We've gained 25 years since 1900. That extra time is added to midlife. We have a second middle age—a period beginning at age 50 to 75."[1] This extended lifespan creates unprecedented opportunities, yet retirement often arrives before individuals have developed a clear plan. The critical questions remain: What are your dreams for the future? What goals matter most during retirement years? The key insight is that what is important to one person will be entirely different to another. That is why determining and designing a strategic retirement plan at an early age is vital to reaching those dreams. The time to do this is now, not later.

Beginning an early retirement plan allows a person to create the kind of work and lifestyle they want. You can study, travel, establish a business, restructure or modify a current position, do volunteer work, or pursue leisure activities that give you a sense of purpose and feelings of accomplishment, confidence, and usefulness. Most people do not realize there is a second "mid-life" period where they can accomplish dreams. There is time to start college or begin a new business. The point is that people should begin as early as possible to think about their dreams, whether they accomplish them during this second "mid-life" or during their senior years.

The central problem is that people procrastinate because they lack the knowledge of how to design a retirement plan or feel that they lack the money to put into savings. However, the purpose of a retirement plan is straightforward: save money in various ways including stocks and bonds for the dreams of retirement. This plan can begin at age twenty or at sixty, but the sooner the plan is written, the better chance of having the retirement funds when they are needed.

Statistics underscore the urgency, particularly for women. Women are twice as likely to live in poverty in retirement. Half of the elderly women living alone have incomes of less than $10,000 per year. Only 20 percent of baby boom women will be financially stable in retirement. Additionally, 33 percent of women avoid making investment decisions for fear of making mistakes. These disparities make early planning not merely advisable but essential. Begin the strategic retirement plan now. Do not wait until mid-life or the second mid-life. Procrastination is the number one problem. An early retirement plan should be started in the twenties.

Understanding investment terms is important before beginning any retirement plan. Here are essential terms and definitions that every retirement planner should know:

401(k): A type of pension plan that allows employees to contribute a portion of their salaries to retirement investments on a tax-deferred basis.

Understanding Investment Terms and Vehicles

Bear Market: A prolonged period of declining stock prices.

Bull Market: A prolonged period of rising stock prices.

Blue Chip Stock: Stock of large, well-known companies.

CD (Certificate of Deposit): A debt instrument issued by a bank that usually pays interest. The maturity date ranges from a few weeks to several years.

DOW (Dow Jones Industrial Average): A popular index to measure and report value changes in representative stock groupings. "The Dow" is a price-weighted average of 30 actively traded blue chip stocks, primarily of industrial companies.

Diversification: Spreading risk by putting assets in several categories of investments—stocks, bonds, and money market instruments—so that any effects of weakening or failure in one area will not be overly serious to the total investment in the diverse portfolio.

IRA (Individual Retirement Account): A personal retirement savings account that offers tax advantages for long-term investing.

At age twenty, establish the foundation of your retirement strategy. Begin with an employer's retirement program. Most of the time, when an employee puts in money, the employer will match the funds. Be sure to contribute enough to get the full matching contribution; otherwise, you are passing up "free" money. Be willing to sacrifice some money today so you can have your retirement dreams. Set goals for the future.

Age-Based Strategic Planning Milestones

Here are several practical ways to save money: Put money in the 401(k) plan at work, cut your long-distance calls, use a consolidating loan to refinance student loans to save on interest, change your tax withholding (W-4) to take out less money, and lower spending by eating at home. Become educated about stocks and bonds. Learn how tax laws affect investments. Try saving at least four percent on the retirement plan. Open an IRA account and put as much money as possible in the 401(k). Pay off credit cards and put those savings into retirement funds.

Different life stages call for different retirement planning strategies. Breaking retirement planning into age-based milestones makes the task less overwhelming and ensures you remain on track.

Strategic Planning at Age Thirty: If you have already started retirement planning in your twenties, continue and refine your approach. If not, now is the time to begin. Slow down on spending, especially on credit cards. Buy a house, even if you are single—real estate can be a valuable retirement asset. Teach children the basics of money management, establishing a family culture of financial responsibility. If your spouse handles the finances, learn how they manage them so you both share financial literacy and planning responsibility.

Strategic Planning at Age Forty: At this midpoint, take a serious assessment. Review any investments that have been made. Increase retirement savings to at least 10 percent of your income. If you have not invested or saved, definitely begin now. Your window is closing but not closed. Update the retirement plan as needed, incorporating changes in income, family situation, or goals.

Fifty Is the Age to Get Serious About Retirement Planning: Do not be so conservative in your approach. Be willing to put money in both stocks and bonds to maximize growth potential. Utilize catch-up contributions that some companies offer. If possible, put an additional $500 in the IRA. Purchase long-term care insurance, which becomes increasingly important as you near retirement. Invest for growth. Update your retirement plan as needed, incorporating recent market performance and any life changes.

Retirement or Re-career: Make serious plans for retirement or a transition into a second career. Put more into the retirement fund during these final working years. Revise your will to reflect your current wishes and family circumstances. Consider beginning some college courses for a second career if you plan to work part-time in retirement. Think about how you want to spend the retirement years—this is as important as the financial planning itself.

Building a strategic retirement plan requires more than aggressive saving; it requires protecting what you save. Choose a financial advisor to review your retirement plan and be willing to accept the changes they suggest. People of retirement age were hit hardest by falling stocks in recent years. It is important to have stock in more than one place. Stocks and bonds are both important in the retirement plan. Seek professional help. Some companies offer free professional help with retirement planning and in buying stocks and bonds. A law that took effect in January allows employers to offer not just education related to your company plan but also broader "retirement advice" to you and your spouse individually, as a fringe benefit. This means your employer could take a tax deduction for the cost, and you would not have to pay taxes on the value of the advice or benefit you receive. Take advantage of this if possible.

Read about financial planning. Subscribe to financial magazines. Do an analysis of your retirement plan. Real-world data illustrates why diversification matters. Average assets per 401(k) participant at year-end showed significant decline: in 1999, $45,681; in 2000, $40,918; and in 2001, $36,390. This three-year decline underscores the volatility of the market and the importance of protective strategies.

Investment Protection and Market Risk

The bear market has slashed the portfolios of workers and retirees alike, but it is retirees who bear the brunt. When asked whether the value of their savings for retirement had changed in the last two years, retirees reported increases averaging 30 percent and workers reported increases of 33 percent. However, many stated that their savings had decreased by over 50 percent. Many feel confident that their retirement fund will be enough when they retire, but over 30 percent of people said it might not be. This is something that must be considered in making and updating the retirement plan.

401(k) and 403(b) Plans: These are both employer-based plans named for the sections of the tax code that created them. They allow employees to save pretax dollars for retirement. For instance, out of a 35 percent combined federal and state tax budget, every $1,000 you save cuts just $650 from your take-home pay. The other $350 would have gone to the IRS and your state's treasury. Some companies match part of the worker's contributions. Beginning in 2002, there was a tax credit that gave more incentive to contribute to a 401(k), aimed particularly at workers who have the most difficulty saving for retirement—the low-income worker.

The bear market has inflicted significant pain on retirement savings. Raises have an effect on retirement funds. If a person does not get a 3 percent raise, it may not seem like much. However, losing even a small amount of salary can add up to big amounts when it comes to retirement savings. It is important to know whether the impact affects your retirement nest egg. Even small changes can add up over a period of several years, so knowing this can help you add to the retirement plan in other ways.

When salary freezes occur, the impact on long-term 401(k) growth is substantial. Consider these scenarios for a 401(k) account without a salary freeze versus with a freeze: at age 55, without freeze the account would reach $277,125 versus $269,953 with freeze; at age 60, $525,362 versus $511,353; and at age 65, $902,048 versus $877,631. These differences compound dramatically over time.

Principal Protected Funds: Who would not like an investment that allows you to participate in a stock market recovery while guaranteeing that you will get your money back if the market continues to fall? That is exactly what a small but growing number of mutual funds, generally known as principal protected funds, promise if you leave your money with them for a set period, usually 5 to 10 years. It is like letting your money sleep at night and knowing it will be there the next morning. The method uses a combination of stocks and bonds. Investment managers like Scudder or ING are firms that offer this service. However, a person can do this independently. The majority of the money goes into bonds that mature in five years.

Here is how principal protection works: Put about 80 percent of $100,000 in zero-coupon government bonds that will mature in five years at the value of $100,000. Put $20,000 into stocks. This is how the portfolio would look in five years depending on market return:

Market Return: 80% Bonds/20% Stocks vs. 100% Stocks

−10%: $118,000 vs. $90,000
0%: $120,000 vs. $100,000
+15%: $122,000 vs. $110,000
+25%: $124,000 vs. $120,000
+30%: $126,000 vs. $130,000
+40%: $128,000 vs. $140,000
+50%: $130,000 vs. $150,000

This strategy protects your principal in down markets while still allowing participation in market gains, though with a slight cap on gains during strong bull markets.

Americans love to spend money, and that includes retirees. Most people try to save money for retirement and look forward to the time when they can sit back and relax. However, even those who save for retirement fail to realize how much actual money is needed. It is essential to get an idea of what you need to be saving today to pay for tomorrow. Kiplinger's Personal Finance has created a worksheet to help with this purpose. Here are the steps:

These worksheets help you account for inflation, which erodes purchasing power over time. For example, money that purchases items for $100 today may cost $120 in five years if inflation averages 3 percent annually. Planning must account for these growth factors.

Calculating Retirement Needs and Income

Money-Growth and Inflation Factors:

Years to Retirement | 3% Growth | 4% Growth | 6% Growth | 8% Growth | 10% Growth | 12% Growth

5 years: 1.16 | 1.22 | 1.34 | 1.47 | 1.61 | 1.76
10 years: 1.34 | 1.48 | 1.79 | 2.16 | 2.59 | 3.11
15 years: 1.56 | 1.80 | 2.40 | 2.17 | 4.18 | 5.47
20 years: 1.81 | 2.19 | 3.21 | 4.66 | 6.73 | 9.65
25 years: 2.09 | 2.67 | 4.29 | 6.85 | 10.83 | 17.00

These multipliers show how much money you will need in future years to have the same purchasing power today. For example, $100 today will need to be $217 in 20 years if inflation averages 4 percent annually.

Nest Egg Requirements for $100 Monthly Retirement Income:

Years in Retirement | 8% Return | 10% Return | 12% Return

25 years: $130,400 | $111,000 | $95,000
30 years: $137,200 | $114,900 | $98,200
35 years: $141,700 | $117,300 | $99,200
40 years: $144,800 | $118,700 | $100,100

These figures show how much you need saved to generate $100 monthly income throughout retirement at different rates of return. A person needing $5,000 monthly income would multiply these figures by 50.

Saving Target Factors:

Years to Retirement | 6% Return | 8% Return | 10% Return | 12% Return

5 years: 0.0143 | 0.0136 | 0.0130 | 0.0123
10 years: 0.0061 | 0.0055 | 0.0050 | 0.0045
15 years: 0.0035 | 0.0029 | 0.0025 | 0.0021
20 years: 0.0022 | 0.0017 | 0.0013 | 0.0011
25 years: 0.0015 | 0.0011 | 0.0008 | 0.0006

These factors show what percentage of your desired retirement fund amount you need to save annually to reach your goal. For example, to accumulate $500,000 in 20 years at 8 percent return, multiply $500,000 by 0.0017, meaning you would need to save $850 annually.

Income for Life: Once a person retires, their retirement plan fund must last through their lifetime. There are different ways to approach this challenge. One way is "do-it-yourself" withdrawals. This approach can be as simple as withdrawing money when it is needed or wanted. Alternatively, you can withdraw a certain amount of the retirement fund and adjust it each year for inflation to keep the purchasing power needed. The advantage to this approach is having control of the retirement fund. If emergencies arise, money can easily be withdrawn. However, the problem is that the temptation to withdraw all the funds at once will be tempting at times. People tend to underestimate their longevity and overestimate the withdrawal rate their portfolio can sustain, and that is a dangerous combination. One way to prevent this is to reduce the withdrawal rate.

The Hybrid Solution: One way to keep the retirement fund growing is to invest part of the money into stocks or bonds. Using any of these methods will help the retirement fund last longer. Perhaps seeing a financial advisor for advice might be wise. However, no method is a guaranteed way of keeping the retirement fund long enough without careful budgeting and saving. Investing the assets is the best way of keeping the targeted withdrawals continuing.

Government Incentives: A consideration that can be made is to wait to retire until age 70, and the government offers an incentive for this delay. For each year you delay between age 65 and 70, you get a credit that will increase your payments by 6.5 percent. Wait until you are 67 to claim benefits, for example, and you will get a 13 percent bonus; hold off until you are 70 and five years' worth of credits will boost your checks by 32.5 percent. When you consider that a person who might be eligible for $1,660 monthly would wait five years, their checks would be $2,200. The question might be asked: Is a bird in the hand worth two in the bush? It might depend upon your health and financial status.

Conclusion: Taking Action on Your Retirement Plan

Retirement plans are important for employees regardless of their age. A person can begin to design their retirement plans as early as age twenty or when they become interested in savings for their dreams during retirement. The time to start is now. Whether you are in your twenties, forties, or fifties, a well-designed retirement plan tailored to your dreams and circumstances can help ensure that you have the financial resources to live the retirement life you envision. Start today—your future self will be grateful.