Studies worldwide have consistently confirmed that people are not saving enough for their retirement or not saving at all. Sadly, with the average age of retirement increasing, more than half of the population can never afford to retire. Start as early as possible - this is the golden advice. But how and where do you start - it is rarely explained.
State pensions and employment pensions were an obvious choice for retirement in the past; however, it is not the reality in the current financial climate. With State and employment Pensions lowering and the average elderly population rising, retirees have to look to other methods to fund their retirement. Here are three retirement planning ideas for 2021:
- Determine your time horizon for retirement;
- Determine the location of retirement and observe the costs;
- Utilising existing investment options.
How to start saving for retirement
When it comes to investing for retirement income, the sooner you start, the better off you'll be because of compound interest. The good news is that even if you've been putting off saving for retirement or haven't started at all, there are steps you can take to boost your retirement fund. All you need to do is ask yourself some basic questions.
When do you want to retire?
The time to retire depends on your personal goals and requirements and your current financial circumstances. Of course, there are some tax and pension benefits to retiring at the retirement age or even later. However, many may not find the idea of working until their 60s desirable. Burn out is real and retiring at 60 when you have little time and energy to enjoy life may not be worth it. Retirement in general has been shown to have a positive impact on both one's health and one's quality of life.
Early retirement is beneficial because you have no work-related stress, you will have more time for your passion and hobbies, and you may even want to start a new career. However, the flip side of early retirement is that you will have a small amount in state and employment-based pension. Your retirement amount has to be significant because you have more time to spend and you will need to buy health insurance since you no longer work full time.
The retirement age in Europe starts at 60, but you can definitely withdraw all of your pensions before the retirement age. The catch is that you will have to pay taxes on it.
How much do you need for retirement?
Imagine what your retirement would look like as it would give you an idea of the cost of living. Account for inflation so that you may be extra prepared for rising costs. Some costs may increase, and some will eventually decrease. For example, your health costs will increase as you age, but your other expenses, like child care, may decrease once your children are independent. However, you must also note that people are prone to spending more in their early retirement because of the availability of time, which many young retirees want to take advantage of (like travelling). Accounting for most of the costs in early and later retirement, you will be able to get a good idea as to how much you need to set aside.
Common suggestions dictate that the retirement amount should be $2 million, while other recommendations state that around 80% of your pre-retirement income should be replaced. There are many online calculators that give you the amount you need for retirement, accounting for inflation, and how much you need to save based on your current income and your age.
Benefits of investing early for retirement
An important benefit of starting early is that you gain a better understanding of the concept of financial independence and can begin planning for it at a younger age. Your financial pattern is revealed, which in turn helps you determine how to manage your investments and money.
Here are some of the benefits of investing in the early stages:
- You will have more time to compound, and as a result, you will be able to accumulate more money in the future.
- Investing early gives you a head start in recovering losses in the event of a financial setback.
- With early investments, you can avoid the burden of borrowing in the event of a financial emergency.
- Rather than being a debtor, you might become a creditor by starting early. The freedom to lend money rather than borrow or take loans will improve your credit score and institutions will be willing to offer you more services at a lower rate of cost.
- In today's world of digital financial management and tech-savvy millennials, diversifying your portfolio is easier than ever. Investing early in today's generation allows you to spread your money over a variety of investments at a much lower cost.
- Investing early reduces the amount of money you have to invest each month. Even if the initial investment is small, the profits will be big in the long run because the investment horizon is so long.
Which investment accounts should I use?
If you want to meet your savings objectives, invest in a way that suits your investing style, and own part of your account, you need the correct kind of investment account. If you haven't already, consider opening the following types of investing accounts:
- Pensions and pensioned based investments
- Investment for retirement outside the pension scheme
- Real estate based investments
Pension and pension based investments
There are three basic kinds of pension accounts: one provided by the state, one provided by your employer and one that you contribute to voluntarily.
Employer-based pensions are reasonably common for people to have aside from state pensions for those who are working. Employer pensions cover not only retirement savings but also healthcare. The benefit of employment pensions supports both the employer and the employee as the employer receives tax breaks, and the employee enjoys financial security.
Every country in the world has its variants of employment pensions, and in some, it is mandatory to offer retirement plans for their employees. The USA provides 401(k), while the UK has a Workplace pension. Estonia offers employment pensions under its Pillar II. However, the contribution made to employee pensions is meagre and will not be enough to rely on. Additionally, to be able to qualify for one, employers must fulfil some criteria. These criteria are subjective to each country. And it also depends if you can keep your job. Hence, it is better if you also opt for a voluntary pension scheme for early retirement. They are often called retirement funds. The benefit of a voluntary pension scheme includes tax breaks.
Moreover, some countries invest the money in funds that ensure more robust retirement security. Again, each country has its version of a voluntary pension scheme. For, e.g. in the UK, you can take early retirement at 62 with their Lifetime ISA. In Estonia, Pillar III offers people to save extra for retirement with tax breaks and allows them to withdraw five years before retirement. There are also private companies that offer voluntary pensions to support their retirement. People have to search for the best retirement planning services near them. You can also explore any retirement calculator online to check your monthly contributions.
Investment for retirement outside the pension scheme
Apart from pensions and retirement funds, many support their retirement by investing externally. The most popular ones include stocks, bonds, and funds, and there are many ways to invest in them:
- People can buy stocks directly or through funds to diversify risk. The goal should be to think long-term and diversify risks. Investors must keep in mind not to panic when prices fall as they tend to fluctuate. Depending on the current age, young investors can take on more risks for greater returns, and as they age, they can reduce their risks by opting for bonds.
- Bonds are safer than stocks as it offers an annual payment on a fixed interest rate. Generally, they provide lower returns and are affected by inflation, therefore, not solely sufficient for retirement. And, of course, even bonds have their risks of defaulting. Nevertheless, the overall aim is to dilute stakes by diversifying, holding both stocks and bonds. Stocks will aid financial growth, while bonds will balance out the risks.
- As mentioned before, investors can buy stocks through funds. For funds, you need to observe whether it is actively managed funds or passive. Actively managed funds charge higher fees than passive ones. But funds, in general, are balanced with growth and risks because they hold stocks and bonds. There are several funds, the most popular ones being mutual funds, index funds, and exchange-traded funds. Mutual funds have a professional fund manager to choose your stocks for you. In index funds and ETFs, you cannot pick stocks, and instead, it tracks a benchmark index. Hence mutual funds are higher in fees than index funds and ETFs. ETFs are similar to index funds, but you can trade them at any time of the day. The funds' goal is to observe the fees - generally, funds with lower costs are more optimal than returns.
Real-estate based investments
Real estate is one of the most well-received ideas for retirement planning. With its prices appreciating, more people want to take a slice of the market to ensure their retirement. Traditionally, those who already can afford to buy real estate will go for multiple real estates for rental income. The problem for many is, however, is the initial investment required. Nevertheless, there are many options available nowadays to participate in real estate investments. It has become more accessible through fin-tech. Crowdfunding is a well-established way to invest in the real-estate market where the crowdfunding company pools capital together from investors and invests in real estate. The company then receives income through rent and payout to the investors. A Real Estate Investment Trust (REIT) is an example of crowdfunding, and it pays its investors through dividends. The income also has tax benefits, and the risk is diluted by having several types of real estate in the portfolio. However, since it's also an investment in one asset class, it also carries some risks.
Summary
One can no longer rely on one income in today's day and age due to rising cost. You will need to expand your income to other sources to ensure that you do not end up without security at your old age. Hence, start investing early. Most of the early retirement planning advice indicates setting on a time horizon of your retirement and the amount you need. The benefits of investing early is that you will have more time to compound and you will not need to start with a significant amount. As a beginner, you can start maxing out all of your pension accounts and then look to investing outside the pension scheme. If you have sufficient capital, you can venture into real-estate or investments that are based on real-estate. Granted, not all of the early retirement planning tips will work and not for everyone and investment and retirement planning can be overwhelming. However, starting somewhere will help you figure out the rest of the path.
The process of achieving retirement has become more dynamic than before. Retirees are no longer relying on one source of income to prepare for their retirement. Most people invest their money to ensure that they can retire with enough resources to live the remainder of their lives. Some even have achieved early retirement - a goal which is becoming more popular. The important fact is to start early, invest your money and ensure that your risks are limited.