What is Retirement Planning?

Retirement planning is the important task of deciding how you will live once you retire. It involves the consideration of a number of factors, including at what age you hope to retire, how much money you will need to cover living expenses coupled with the things you plan to do once you've retired, and where your money will come from. Generally speaking, retirement planning is planning your finances for the period of life after you stop working.

Each person's situation is unique, and therefore, retirement planning isn't one standard plan for every person. Saving money for retirement through one or all of the available options is the first place to start. Many employers have retirement planning options available to their employees. Some companies have pension plans, others have 401(k) plans, and some have a combination of both. There are different types of pension and 401(k) plans, and you should check with your company's human resource department for information specific to you.

Even without company sponsored plans, retirement planning is possible for any individual who wisely invests his or her money. You can choose to talk to a financial planner, but usually for a fee. Another option is to discuss investment and savings options with the bank where you currently have your checking or savings account. Many banks offer free advice to their account holders hoping to gain more of their business through long-term savings.

​Retirement planning involves more than just saving money. It's important to determine as closely as possible what your potential expenses and compare them to your potential income. For instance, if you will be able to pay your mortgage off before retiring, that is one less expense you'll need to cover. It may be necessary to find a way to pay an extra small amount towards your mortgage while working in order to have that debt absolved before retirement, thereby lowering the amount of money you will need each month.

Depending on what age you hope to be when you retire, retirement planning should also involve tax planning. By doing a little research and talking to financial professionals, you should be able to come up with a savings and investment plan that works for you. You can begin retirement planning at any stage in life, though earlier is better. Be prepared to make changes in your plan as your life changes, and when you finally reach retirement, the planning you've done will leave you better prepared to relax knowing your finances are taken care of.

Types of Retirement Plans

The first step to understanding your retirement benefits is to find out what kind of retirement plan your employer has. There are two major types of plans, defined benefit and defined contribution, which are described here and outlined in Table 1. Keep in mind that your employer may have more than one type of plan, and may have different participation requirements for each.

• A defined benefit plan (often called a pension), funded by the employer, promises you a specific monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement.  Or, more often, it may calculate your benefit through a formula that includes factors such as your salary, your age, and the number of years you worked at the company. For example, your pension benefit might be equal to 1 percent of your average salary for the last 5 years of employment times your total years of service.
  
  
• A defined contribution plan, on the other hand, does not promise you a specific benefit amount at retirement. Instead, you and/or your employer contribute money to your individual account in the plan. In many cases, you are responsible for choosing how these contributions are invested, and deciding how much to contribute from your paycheck through pretax deductions. Your employer may add to your account, in some cases by matching a certain percentage of your contributions. The value of your account depends on how much is contributed and how well the investments perform. At retirement, you receive the balance in your account, reflecting the contributions, investment gains or losses, and any fees charged against your account. The 401(k) plan is a popular type of defined contribution plan. There are four types of 401(k) plans: traditional 401(k), safe harbor 401(k), SIMPLE 401(k), and automatic enrollment 401(k) plans. The SIMPLE IRA plan, SEP, employee stock ownership plan (ESOP), and profit sharing plan are other examples of defined contribution plans. (See explanations of the various types of plans in the Glossary at the end.)

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