Many people wonder whether their income and assets will support them throughout retirement. Thoughtful, tax‑aware financial planning can help improve long‑term retirement readiness by making the most of available tax benefits and supporting compounding over time. While results vary, tax‑efficient strategies can help investors keep more of what they earn.
In this month’s blog, we outline eight educational approaches that could help strengthen your retirement plan. From using tax‑advantaged accounts to building a taxable bridge portfolio and developing a tax‑efficient withdrawal strategy, these concepts can help you make informed decisions based on your goals and circumstances.
- Maintain an accurate, up-to-date, financial plan. You won’t know if you’ll have enough saved to retire unless you know the end goal. A clear, accurate financial plan allows you to calculate the age at which you hope to retire, how many years you’ll spend in retirement, fluctuating factors like cost of living, and the annual savings rate required to reach your goal.
- Spend less than you earn and invest the difference. Retirement readiness requires disciplined, consistent savings and lifestyle changes to make it a reality. More than merely having a budget with income that’s greater than your expenses, you must prioritize eliminating debt and controlling spending, so your habits are sustainable throughout retirement. It’s also critical to have a savings strategy that will yield the greatest benefit over time.
- Leverage tax-advantaged accounts. Maxing out contributions to retirement accounts, such as a workplace 401(k) or IRA, not only reduces your annual taxable income and maximizes an employer match but also could accelerate compounding. The longer your money stays invested, the more time it has to benefit from potential growth. Additionally, using Roth IRAs can provide tax-free income later in life and offer greater flexibility during retirement.
- Actively minimize taxes. More than simply using tax-advantaged retirement accounts, the asset location and allocation of your investment portfolio can have an impact on your overall tax burden. Working with a financial advisor who understands taxes can help optimize your placements, as well as offset capital gains tax by selling underperforming assets—a proactive strategy called tax-loss harvesting.
- Create a taxable bridge portfolio. Withdrawing from retirement accounts early (before 59-½) can have significant penalties and deplete the resources you need for retirement. Establishing a taxable brokerage account can give you access to invested funds for the years between early and traditional retirement ages. Broad, diversified funds with low fees are often used for this type of bridge portfolio and can give you greater flexibility in early retirement.
- Maximize growth but be mindful of risks. The stock market can be one of the single greatest ways to grow wealth over time, but this growth potential is accompanied by risks of market volatility. Market ups and downs are less impactful when investors have long time horizons to recover before the funds are needed. However, as you near retirement, safer instruments like bonds and cash can keep you from panic-selling investments during market downturns. Balancing the desire for growth with the need to manage risks is essential to stay on track with your financial plan.
- Protect yourself from surprises. Large, unexpected expenses can force you to dip into savings otherwise needed for retirement. Maintaining emergency funds and sufficient insurance coverage is important long before you retire to protect you from potential surprises. However, don’t forget to plan for healthcare costs before Medicare eligibility kicks in at age 65. A lapse in health insurance between your employer-sponsored plan and Medicare coverage could quickly chip away at your retirement savings.
- Develop a tax-efficient withdrawal strategy. How, when, and in what order you withdraw from accounts can have a significant impact on your tax liability. A tax-efficient withdrawal strategy seeks to not only avoid penalties but also keep you in the lowest tax bracket possible to ensure your money lasts through retirement.
There is no magic formula for retirement readiness, but if there were, starting early, investing consistently, and reinvesting dividends and interest to benefit from compounding would certainly be parts of the equation.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
Sources:
https://www.fidelity.com/learning-center/personal-finance/how-to-retire-early
https://www.schwab.com/learn/story/can-you-afford-to-retire-early
https://www.usbank.com/retirement-planning/financial-perspectives/how-to-retire-early.html