The “three-legged stool” of retirement consists of pensions, social security and savings. Ordinarily, the majority of American workers should feel about your purchasing power once your retire.
However, a comfortable retirement is becoming less accessible for Americans. According to CNBC, more than 40% of retirees aged 60 and above rely on social security alone.
Social security was not designed to serve as a sole source of income in retirement. The Social Security Administration estimate its payments only replace around 40% of your annual pre-retirement earnings.
For American retirees to enjoy a comfortable retirement, you need to replace at least 70% of your pre-retirement earnings. The shortfall is typically made up of workplace pensions and savings.
Organizing your financial future once you retire has to include tax planning. By the time you reach retirement, Government tax reforms, IRA conversions, personal income rates and tax bias against savings will erode your pension fund.
Putting some money aside in a traditional pension plan can help to protect your retirement income from being eroded by the tax. However, that is rarely the case.
There are two common types of retirement accounts that are designed to minimize your tax bills; tax-deferred accounts and tax-exempt accounts.
Tax-deferred include traditional IRAs and 401(k) plans. They allow workers to make immediate tax deductions up to the full amount of your contribution but are subject to tax each time you making a withdrawal in retirement.
In addition, The Economic Policy Institute reports that 401(k)s have failed most Americans.
Tax-exempt accounts such as Roth IRA and Roth 401(k) enable retirees to withdraw funds without being taxed. Either of these accounts protects your retirement income.
However, when you switch from a traditional tax-deferred account into a Roth version, you are taxed on the amount you convert. It is, therefore, in your best interests to convert to a Roth version when you are in a low tax bracket.
The Benefits of the Compounding Effect
It is clear that the traditional path to a comfortable retirement is limited. Investors need a third option – investing your savings in financial vehicles that enable you to benefit from the “compound effect.”
Compounding is a term given to assets that generate earnings through interests which are reinvested so that you also make money on your interest. Compounding is the most effective means of accruing a store of wealth.
Investing in assets has the potential to transform your savings into an income-generating tool. The sooner you invest in assets, the more potential you have of recovering higher returns.
To enjoy the full benefits of the compounding effect, the original investment should remain invested together with reinvestment of earnings.
In times of economic uncertainty when financial markets are more volatile than usual, there is a greater chance that you may not accrue as much as you would like.
The smart strategy is to entrust your investment with an independent financial advisor that can move your money around with the rise and fall of the stock market.
For more information about maximizing your retirement spending, get in touch today for a quick 10-minute call.