Source: sxc.hu Photo: CraigPJ

Source: sxc.hu Photo: CraigPJ

Retirement is one of those nebulous goals that we set for the future. Often, we do little beyond think about retirement, and perhaps set money aside through a retirement plan offered by an employer. However, preparing for a prosperous retirement requires active planning and action now. Otherwise, you’ll find yourself, five years away from your target retirement date, wondering how in the world you will ever catch up. Here are a few things worth considering when preparing for a prosperous retirement:

1. Where you are now

Before you can plan for the future, you have to have a pretty good idea of where you are right now. Once you have taken a brutally honest look at your present situation, you can start planning what to do in order to change the path you are on and reach your retirement goals. Look at your debts, expenses and income. Consider what you can do to pay off your debt (including your mortgage, if possible) by the time you retire. Look for ways to boost your income through active or passive means.

2. How much you need for a comfortable retirement

Once you know where you are, you need to figure out where you need to be. Figure out how much money you will need to live comfortably during retirement. There is no one way to determine this. In the end, you have to look at what you can expect from Social Security (not much), company retirement plans and pensions, savings, and any passive income you have set up. You will also need to look at your expenses. If you create a plan to help you pay off debt by the time you retire, this will dramatically reduce your outflows. Add up you current expenses, and estimate how much future expenses for things like long-term care, travel, setting up college funds for grandchildren and health care might add to that. Personally, I think that my expenses overall will be very similar to what I have now. My mortgage, car and student loan payments will be replaced by other expenses (hopefully involving lots of travel).

Using the 4% rule to figure out how much of a nest egg you need

After deciding how much you will need to live comfortably, it is time to estimate how much of a nest egg you will require. Most investment and personal finance experts agree that, in order to make your money last indefinitely, you can withdraw no more than 4% of your assets each year. This will help shield you from inflation and years when returns may not be as good. The idea is that you will be living on your returns, without touching the principal. If you think that you will need $60,000 a year to maintain a comfortable lifestyle, take that number and divide it by 0.04. The answer is $1.5 million. That is how much you will need to have saved up in order to live indefinitely on $60,000 a year. If you think that you will only need $40,000, you can perform the same calculation: 40,000 / 0.04 = $1 million.

Naturally, if you don’t mind having the money run out in 20 or 30 years, or if you keep some source of income going, you can adjust your withdrawals to fit your needs.

3. Make a plan

Now that you have a goal to reach, it is time to make a plan to reach it. Look at what you are setting aside, and figure out whether it is enough to grow your money sufficiently. There are a number of investment calculators and asset allocation models that can help you figure out how much you need to be setting aside now to help reach your target later. Once you have a plan, you need to start following it in order to increase the chances that you will reach your goals. Of course, the earlier you start, the more success you are likely to have. You may even need to see a financial planner or adviser to help you map out a way to save, invest and spend in a way that will lead to later prosperity.

4. Other things

There are plenty of other things that are worth looking into as you prepare for a prosperous retirement. Here some questions to ask and avenues to explore as retirement draws near:

  • Open as many tax-advantaged retirement accounts between you and your spouse as possible.
  • Question your company retirement plan, and find out if you can change the allocation in your account, or self-direct some of the investments.
  • Find out about the tax implications of moves you make now, and when you withdraw funds during retirement.
  • Remember that inflation is always waiting to erode your earnings.
  • Think about down-sizing as retirement nears. Consider a smaller, less expensive home, fewer cars and getting rid of stuff you do not normally use.
  • Consider income investing and other passive income streams.

In the end, it is possible to plan for a prosperous retirement. But you have to take an active role in its accomplishment. It may seem like a lot of work to figure out how much you need and put together a plan, but it is worth the time and effort. After all, the earlier you start, the longer compound interest will have to work wonders in your favor.