Retirement planning should begin the moment you receive your first paycheck. There is a whole host of decisions that ultimately needs to be made before you can retire and planning those beforehand will give you the best chance of meeting your goals and the most peace of mind.

The decisions that will have the largest effect are choosing when to take Social Security, how to invest your 401(k), how to fund your individual retirement accounts, and how to make sure you have enough money in retirement. For all of these, planning early will help you tremendously. Make time work for you instead of against you.

Retirement Budget

Your lifestyle in retirement is very likely related to your lifestyle before retirement. We do not recommend trying to reduce your lifestyle in order to retire. Eating less and dying young isn’t a good retirement strategy.

Measure your lifestyle spending. Your standard of living is used to determine many other aspects of comprehensive wealth management. This will help you determine what you need to save in order to retire. Knowing that will help you know how aggressively you need to save and whether you’re on track. The value of investing, through the magic of compound interest, has a greater effect the more time it’s given. The earlier you start, the less you need to save each year.

Individual Retirement Accounts

There are two kinds of individual retirement accounts (IRAs): Traditional and Roth. Traditional IRAs require you to withdraw a certain amount each year after you turn 70 1/2 and that amount is taxed (this is true of 401(k)s too). These distributions obey simple rules and we explain them here. Roth IRAs do not require you to withdraw anything.

Wealth management is based on the idea that small changes can yield enormous gains over time. When we do a tax analysis we look at a client’s projected tax situation between their current age and age 100.

What we’ve seen is that a client who has significant assets in traditional retirement accounts at age 50 (say $1 million) are projected to have very high required minimum distributions in their late 70s and early 80s. The reason this is a problem is that investments double every 10 years (a return of about 7%). By age 82, they will have $8 million in their traditional retirement account. With $8 million, their required minimum distribution divisor at age 82 would be 17.1 and their annual required distribution would thus be $467,836. That would suddenly become taxable income, leading to a huge tax bill. You do end up with a significant amount of money after taxes, but the required minimum distributions are painful.

It is often better to fund a Roth IRA because the Roth IRAs funds will never be taxed again. The account could grow just as large as the Traditional IRA, but none of it would be taxable. Planning to fund your Roth IRA early is one of the best financial decisions you can make.

But not everybody knows to do that. For clients who have Traditional IRAs, those funds can be converted to a Roth by withdrawing it from the Traditional IRA, paying the tax due on it early, then putting it in the Roth to let the savings grow tax-free. We have found that clients with significant investments in traditional retirement accounts often benefit from small Roth conversions each year. Even a Roth conversion as small as $10,000 a year over ten years reduces your traditional retirement balance by $100,000. Three decades of doubling would then produce an $800,000 Roth account with that much less in your retirement accounts subject to required minimum distributions. Roth conversions also reduce the size of your investment in taxable accounts simply by paying the tax early.

Either way, planning early can help you avoid having to take painful required minimum distributions.

Employer Retirement Plan (e.g. 401(k))

Planning how to invest your company’s retirement plan can be done at any time. A good analysis can help you find the highest return funds with the lowest volatility and lowest expenses.

We recently analyzed the University of Virginia’s Fidelity retirement options for their 403(b) plan and 401(a) plan.

Most 401(k), 403(b), and 401(a) plans are populated by funds with very high fees and expenses. Using the funds in the University of Virginia’s Fidelity plans, we were able to build diversified asset allocations with expense ratios of 0.15% and under. But some of the fund choices had expense ratios as high as 2.26%. The earlier you find out about these, the better.

Many retirees should roll their company retirement plan into an IRA simply to increase the investment options and to lower their fees and expenses. There are only a few cases where leaving investments in your company retirement plan is beneficial. One example is when you will continue to have a high income, are continuing to work, and want to be able to make a backdoor Roth contribution (not a common situation for people nearing retirement). This plan gives you the best options for saving for retirement, but takes time.

But the most important part of the plan isn’t just rolling your 401(k) into an IRA. The critical part is to smooth your income for tax purposes by taking advantage of the gap years between your last paycheck and when you will need to start taking Social Security and required minimum distributions. These gap years are also prime times for Roth conversions.

Social Security

The final decision on Social Security can be made at any time up until actually filing for Social Security and beginning to take it, but you can do the analysis of when to claim Social Security at any time.

Relying on Social Security workers for help results in costly mistakes. The way most retirees take Social Security loses $150,000 or more when compared with the optimum method.

Before you can compute your safe spending rate in retirement you would need to know how much of your Social Security (which you may not be taking until age 70) can be spent if you are retiring earlier than age 70. How to factor Social Security into your safe withdrawal rate is a complex calculation. Most retirees err either by not discounting Social Security enough or by discounting it entirely.

Plan early so you know whether you will need to depend upon Social Security and should file early or whether you can wait and get the best value possible. At a minimum you should create your own Social Security account online and give it a very secure password. If you don’t, someone else might be able to create an account for you by answering a series of security questions.

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