Retirement planning is the process of thinking about — and saving for — retirement. Even if it seems far away now, contributing to your retirement savings early and often gives you the best chance to enjoy your golden years in style.  

To bring your retirement dreams to life, start by deciding how much retirement income you need — and where to stash it. Let’s take a look at how to plan your retirement savings.

Key sources of retirement income

A regular savings account won’t be the most efficient way to save for retirement — you’ll need to maximize your compound interest potential, where profits grow more profits through investing. Here are a few common sources of income in retirement:

Social Security benefits 

Retirement benefits from Social Security provide monthly guaranteed income and increase periodically to offset inflation. Unlike other retirement accounts, you don’t make direct contributions into an account but, instead, earn Social Security by working and paying employment-related taxes. 

Retirement accounts

Retirement accounts let you contribute to a tax-deferred or even tax-free account. Many employers sponsor retirement accounts like 401(k)s, 403(b)s, 457s, or SIMPLE or SEP IRAs. You can also invest in an IRA (individual retirement account) if you’re eligible. Then, when you reach retirement age, you can start making withdrawals and enjoy the benefits of long-term compound interest. 

Pension plans (defined benefit plans)

Pension plans are becoming less common, but government institutions, insurance companies, hospitals, universities, and larger companies may still offer them. These defined benefit plans pay out a specified amount based on your:

  •  Age
  • Pre-retirement earnings
  • How long you worked for your employer

Importantly, many plans won’t vest and pay benefits unless you stay employed for a few years. Typically, this happens between 3–7 years of employment. 

Annuities

An annuity is a financial product offered by some insurers. When you retire, you’ll receive fixed or variable payments, guaranteeing (relatively) steady passive income. (We’ll come back to this one!) 

Financial planning for retirement

Retirement financial planning refers to setting retirement goals and saving to meet them. The amount of time you have until retirement, your desired spending level, and your risk tolerance will all inform the best savings plan for your situation. 

You’ll want to prepare for expenses and circumstances that will impact your retirement age and how much you’ll need in retirement like:

  • Healthcare costs
  • Housing expenses
  • Utilities, groceries, and other essentials
  • Whether you plan to keep working in retirement
  • Travel expenses
  • The ever-rising cost of living
  • Your current and future tax situation

The older you are, the more you may need to catch up on saving. If you plan to retire early, you’ll need an even bigger nest egg. 

How much will you need? Use our free retirement income calculator

A common piece of retirement investment advice is to save 10–12x your pre-retirement salary. (So if you made $100,000 per year, you’d need to save at least $1 million.) This advice generally assumes you’ll spend less than your pre-retirement salary in retirement, which may or may not be reasonable. 

That’s where our retirement calculator comes in handy. It calculates how much you’ll need to save for retirement based on your:

  • Age and gross (pre-tax) annual income
  • Current savings
  • Monthly savings
  • Desired monthly income in retirement

You can also experiment with factors like inflation rates, estimated investment returns, and retirement age to examine how you’ll fare in various situations. Then, you can use this information to prepare a long-term savings plan and stay on track to meet your goals. 

Bear in mind that these numbers are projections and aren’t guaranteed. As economic conditions and your own financial situation change, you may have to adjust course. Still, it’s a useful starting point for calculating your desired nest egg! 

Retirement accounts and how they work

Every retirement account operates differently, and not every retirement account is ideal (or available) for every individual. Here are a few considerations that may affect your retirement age and savings plan.

Traditional vs. Roth accounts

401(k)s and IRAs both offer a traditional and Roth version.

Traditional accounts are tax deferred, meaning that you contribute pre-tax dollars and reduce your current income tax bill. But there’s a catch: when you make eligible withdrawals in retirement, you’ll pay income taxes on every dollar.  

By contrast, a Roth account allows you to contribute post-tax dollars. You won’t reduce your taxable income now — but you’ll enjoy tax-free withdrawals in retirement. (Even on your capital gains!) 

Generally, a traditional IRA or 401(k) works for individuals who expect to earn (or withdraw) less income and generate smaller tax bills in retirement. But if you expect to earn more in retirement, a Roth IRA or Roth 401(k) can minimize that pesky income tax bill. 

Retirement ages vary

The IRS’s minimum retirement age for tax-advantaged and tax-deferred accounts may affect when you access your retirement savings.

Typically, withdrawing money before age 59.5 carries a 10% early withdrawal penalty on top of your income tax bill. That applies to your 401(k), IRA, 403(b), and even your retirement annuity. (There are some limited exceptions, such as using the funds for higher-education expenses.) 

That said, since the average retirement age in the United States was 64 in 2022, most retirees may not have to worry about withdrawal penalties. 

Social Security benefits work a bit differently. Technically, you can start collecting partial payments as young as 62, but you won’t be entitled to your full check if you withdraw before full retirement age. 

Required minimum distributions

According to the IRS, individuals must start withdrawing required minimum distributions (RMDs) at age 72 from accounts like IRAs, 401(k)s, and 403(b)s. Failing to do so can incur a whopping 50% tax bill on the amount you didn’t withdraw.  

Expected investment returns

It’s impossible to guarantee that any investment will generate long-term investment returns. However, historical data can provide clues about long-term earnings potential. 

For instance, the S&P 500 index is a stock market benchmark that averages around 10% in investment returns annually. Balanced investment portfolios often include the S&P 500 to generate performance.

Your retirement investment strategy

No investment strategy is foolproof. But with careful planning, you can spread your retirement savings into different assets and create a well-diversified retirement portfolio. 

The goal is to reach your desired investment returns while minimizing market volatility. 

For most people, that means relying on a mix of:

  • Social Security benefits
  • Retirement account withdrawals
  • Brokerage account investments
  • Fixed-income investments like bonds, CDs, and money market funds

If you’re not sure where to start, an ETF or mutual fund linked to the S&P 500 has historically produced a stable track record. (Remember that average 10% annual return?) You can also invest in fixed income like bonds to generate regular dividends while maintaining some much-needed liquidity. Be careful about holding cash that does not yield significant interest — its value gets eaten away by inflation.

Try to “max out” whenever possible

When it comes to saving, aim for your annual maximum contribution limit whenever possible. 

For instance, in 2023, you can contribute up to $22,500 to your 401(k) and $6,500 to your IRA. (Other accounts may have different contribution limits.) You can also make additional “catch-up contributions” to these accounts if you’re over 50. 

Should you invest in an annuity?

An annuity is a financial product sold by an insurance company;

  • You pay the company a lump sum or series of payments
  • The company may invest your funds to generate higher returns
  • The insurer then pays you regular, passive income following a predetermined date or event

Although annuities sound similar to investment products, they differ by offering a contractual agreement to pay out a regular, guaranteed income stream. Some annuities also invest in other assets, linking their payment amounts to market performance. 

Investors and retirees may buy annuities thanks to the guaranteed income and customizable policies. However, they’re not risk-free. Many annuities carry high commissions and fees. Also, if you withdraw your money early, you may have to pay a “surrender charge” or a tax penalty. 

Other sources of retirement income

If you’re looking to boost your retirement savings pre-retirement or boost your retirement income after you’ve left the workforce, consider:

  • Selling your current residence and downsizing to a cheaper home or location
  • Investing your cash in a high-yield savings account or CD
  • Investing in rental properties to increase your passive income
  • Starting your own side hustle or small business
  • Getting a part-time job — perhaps with healthcare benefits — to increase your income and offset certain costs
  • Engaging in freelance consulting work to profit off a lifetime of expertise
  • Tapping your veteran’s benefits or inheritance (if available)

Of course, the best course of action to prepare for a well-funded retirement is to save early and often. But if you got a late start on your pre-retirement savings, you’re not alone! You can keep building your nest egg as you approach retirement — and even beyond.