One of the most basic steps that people take when preparing for retirement is to begin making regular contributions to an employer-sponsored retirement account. There are exceptional benefits for doing so, such as taking advantage of tax-related benefits and hopefully benefiting from employer contributions to this account. However, if your plan is to rely solely on distributions from your retirement account in the later years of your life, you may want to think again.
The Problems With Solely Relying on Retirement Account Distributions
There are a few primary issues associated with solely relying on your retirement account for income later in life. First, there is a cap on the amount of money that you can contribute to these accounts. Depending on when you start investing and what your growth rate is, there is a fair chance that your account balance may simply be inadequate for your needs later in life. Second, many people invest only in this type of account, and this means that the majority of their assets are not liquid in the event of an emergency or if they want to retire early. Taking penalties on early withdrawals can work against you. Third, distributions decrease your account balance. If you fail to properly plan for inflation, taxes and account fees, there is a good chance that you will eat into your account balance too quickly. When this happens, you face the very real likelihood of running out of money well before you pass away.
The Need to Purchase Other Types of Investments
As you can see, it can be financially risky to put all of your proverbial eggs into one basket when planning for retirement. It is wise to fully fund your retirement account, but for most people, additional effort is needed to create multiple income streams to rely on in retirement. For example, many people will also fund a Roth IRA, invest in a personal non-retirement stock portfolio and even purchase annuities or investment real estate to create a more well-rounded retirement plan. It is important for you to explore various investment types to determine the right allocation for your retirement plans.
The Importance of Understanding How Various Investments Provide Income to You
Some assets, such as a retirement account, are designed to produce income for you by eating into the core value of the asset. For example, each time you receive a distribution from your retirement account balance, your balance will be reduced. Unless you have a very high starting balance with a great rate of return maintained at that level over time, your balance will decline over time. You risk running out of money. Other investments, such as dividend-producing stocks and real estate investments, may produce regular income for you in retirement without digging into the core value of the asset. With these types of assets, the assets may actually continue to increase in value while you benefit from the income streams they create. You can sell the asset at any time without penalty, generally for a substantial profit. In addition, with these assets, there is no minimum or maximum retirement age you must comply with.
How to Find the Right Mix of Investments
One of the most challenging aspects of retirement planning relates to finding the right mix of investments to rely on in your retired years. In an ideal scenario, you may be fully maxing out contributions to a 401k as well as a Roth IRA, and you may also be contributing funds to a non-retirement stock account. Over time, your stock account balance may get large enough that you can comfortably invest in a couple of investment properties. However, most people find that they do not have wiggle room in their budget to fully fund their 401k, much less to make other necessary retirement investments. A smart idea is to allocate a modest portion of your savings and investment funds into a non-retirement account so that you are liquid in the event an emergency situation arises. Take steps to pay off debts and to reduce your expenses, and this will free up additional money that can be allocated toward investments. Use your annual raises and bonuses to more fully fund retirement accounts. Over time, you may find that you have even more money to save and invest.
While your primary inclination for dealing with retirement planning may be to throw every last dollar you can find into your retirement account, you can see that this is not wise. Instead, consider how you can find a happy medium between savings and retirement investments and how you can increase your contributions in the months and years to come.