No retirement plan is perfect. There are plenty of things out of our control that could negatively impact our ability to save for retirement. However, there are certain things that every retirement savings plan should have. Here are five necessities for a solid retirement plan:
Use tax-advantaged accounts. Every good retirement plan should have some tax savings. You can't control future tax rates, but you can control when you are taxed. When you put your after-tax money in a Roth IRA or Roth 401(k), you won't have to pay taxes on the earnings upon withdrawal in retirement. If you have a traditional 401(k) or IRA, you get a tax break in the year you make the contribution, but the money you place into that account and the earnings are taxed in retirement. Regardless of which tax-advantaged account you use, you will see some tax savings. And by using both Roth and traditional retirement accounts you will add tax diversity to your portfolio. This will give you more control over how and when you pay tax on your nest egg.
Choose no fee accounts containing low-cost investments. You don't have to pay to play when it comes to retirement investing accounts and specific investments. Many investment expenses can be avoided when saving for retirement. Stay away from retirement accounts that have big management fees and avoid individual funds with load fees and high expense ratios. Unless you can be certain that you're getting back more value than you are paying in expenses, skip the premium investing services and funds. History has shown that over the long haul, less expensive funds are better.
Select a proper asset allocation. The investments within your retirement savings account should reflect your age and risk tolerance. If you don't know your risk tolerance, take one of the many free questionnaires online. Also, take time to study the different asset classes and learn what makes them more or less of a risk for you. As your age and your risk level changes due to life circumstances, your mix of investment asset classes should change accordingly. Be sure to maintain a proper asset allocation.
Controlled by you. You don't have to necessarily fly solo when it comes to your retirement savings, but you need to be the one at the helm. The more control you have over your retirement accounts, the better you'll be able to ensure that your taxes, fees, and asset allocation remain at reasonable levels. In this era of personal investing, you can establish and build a solid retirement savings account using your own tools and freely available information.
Big enough to last throughout your retirement. Your retirement savings account needs to be big enough that you can count on it to see you through your retirement years. If you are just starting to save, meet with an adviser or find a retirement calculator and determine your retirement needs. Make sure your monthly contributions are enough to get you where you need to be.
Philip Taylor is the author of 104 Ways to Save Extra Money. Read his popular blog, PT Money: Personal Finance for more insightful money tips, like his recent suggestions for the best online checking accounts.