Retirement Planning

The Big Idea

Retirement planning is really income replacement planning. At some point you want work to become optional, and that means your savings and investments need to cover the life your paycheck used to fund.

Why It Matters

The reason to care now is simple: Social Security usually won't do the whole job, and healthcare gets expensive right when you most want stability. Waiting doesn't make the math kinder.

The Breakdown

401(k) vs IRA: The Retirement Account Showdown

Both are tax-advantaged retirement accounts, but they work differently:

• 401(k): Offered through employers. 2025 contribution limit: $23,500 (plus $7,500 catch-up if age 50+). Contributions are pre-tax, reducing your taxable income now. Growth is tax-deferred. You pay taxes when you withdraw in retirement. Many employers offer matching contributions—free money you should always take.
• Traditional IRA: Individual account you open yourself. 2025 contribution limit: $7,000 (plus $1,000 catch-up if age 50+). Contributions may be tax-deductible depending on your income and whether you have a workplace plan. Growth is tax-deferred. Taxes are paid on withdrawals in retirement.
• Roth IRA: Contributions are after-tax (no deduction now), but growth and withdrawals in retirement are tax-free. 2025 income limits: phase-out starts at $150,000 (single) / $236,000 (married). Contribution limits same as Traditional IRA. Best for those who expect to be in a higher tax bracket in retirement.
• Roth 401(k): Increasingly offered by employers. Combines the higher 401(k) contribution limits with Roth tax treatment. No income limits. If available and you expect higher taxes in retirement, consider splitting contributions between traditional and Roth.

Which should you choose? Priority order: (1) 401(k) up to the match—free money first. (2) Max out Roth IRA if eligible—tax flexibility. (3) Max out 401(k) to the $23,500 limit. (4) Taxable brokerage account for additional savings. The traditional vs. Roth decision depends on your current tax bracket vs. expected future bracket—when in doubt, diversify with both.

The 4% Rule: How Much You Can Withdraw

The 4% rule is a guideline for sustainable retirement withdrawals. Based on historical market data, withdrawing 4% of your portfolio in year one of retirement, then adjusting for inflation each year, gives you a high probability of not running out of money over a 30-year retirement.

How to use it: Multiply your annual retirement expenses by 25 to get your target nest egg. Need $60,000/year? You need $1.5 million (60,000 × 25). Want to be more conservative? Use 3.5% (multiply by 28.6) or 3% (multiply by 33.3).

Important caveats: The 4% rule assumes a 30-year retirement, a balanced portfolio (50–60% stocks), and that you stick to the plan regardless of market conditions. Early retirees (30–40 year retirements) should use a lower rate (3–3.5%). Sequence of returns risk—the danger of poor market returns in your first years of retirement—can derail the plan. Flexibility helps: being able to reduce spending 10–20% in bad years makes the 4% rule much safer.

Social Security: What to Expect

Social Security is a government program that provides retirement, disability, and survivor benefits. It's funded by payroll taxes (6.2% from you, 6.2% from your employer, up to a wage cap that changes annually).

• How benefits are calculated: Based on your 35 highest-earning years, adjusted for inflation. Work fewer than 35 years and zeros are averaged in, reducing your benefit.
• Full Retirement Age (FRA): The age when you receive 100% of your calculated benefit. It's 66–67 depending on birth year (66 for those born 1943–1954, gradually increasing to 67 for those born 1960+).
• Early retirement: You can start benefits at 62, but they're reduced by about 25–30% compared to FRA. This reduction is permanent.
• Delayed retirement: Waiting past FRA increases benefits by about 8% per year until age 70. Delaying from 67 to 70 increases benefits by roughly 24%.
• Taxation: Up to 85% of Social Security benefits may be taxable depending on your total income. If Social Security is your only income, it's probably not taxable. But with other retirement income, expect some taxation.

When to claim? The break-even point for delaying is typically in your early 80s. If you live longer than average, delaying pays off. If you have health issues or need the income, claiming earlier makes sense. Married couples have more complex decisions—often one spouse should delay for the higher survivor benefit. Consider working with a financial planner for this decision.

Healthcare in Retirement: Medicare Basics

Medicare is federal health insurance for people 65+ (and some younger people with disabilities). It's not free, and it doesn't cover everything.

• Part A (Hospital Insurance): Covers inpatient hospital stays, skilled nursing, hospice, and some home health. Most people don't pay premiums (paid through payroll taxes while working), but there are deductibles and coinsurance.
• Part B (Medical Insurance): Covers doctor visits, outpatient care, preventive services, and medical supplies. Premium is income-based (most pay around $175/month in 2025, higher for high earners). Has an annual deductible and typically covers 80% after that—you pay 20%.
• Part D (Prescription Drug Coverage): Optional coverage for medications. Premiums vary by plan. Has a coverage gap ("donut hole") where you pay more after initial coverage limits are reached, until catastrophic coverage kicks in.
• Medigap (Medicare Supplement): Private insurance that covers what Original Medicare doesn't—deductibles, coinsurance, and foreign travel. You pay an additional premium for this coverage. Best purchased within 6 months of enrolling in Part B when you have guaranteed issue rights.
• Medicare Advantage (Part C): An alternative to Original Medicare. Private plans that bundle Parts A, B, and usually D. Often have lower premiums but limited provider networks. May include extras like dental and vision. You generally can't have both Medicare Advantage and Medigap.

What Medicare doesn't cover: Long-term care (nursing homes, assisted living), most dental care, eye exams for glasses, hearing aids, and cosmetic surgery. These out-of-pocket costs average $300,000–$600,000 per couple in retirement. This is why long-term care insurance and additional savings are critical.

Withdrawal Strategies

Once you're retired, how you withdraw money matters for taxes and longevity:

• Tax-efficient withdrawal order: Generally, withdraw from taxable accounts first, then tax-deferred (traditional 401k/IRA), then tax-free (Roth). This allows tax-advantaged accounts to grow longer. But if your income is low early in retirement, consider Roth conversions to fill low tax brackets.
• Roth conversions in low-income years. If you retire before claiming Social Security and before RMDs start, you may have years of low taxable income. Convert traditional IRA money to Roth at low tax rates (10–12%). That money then grows and can be withdrawn tax-free later.
• Qualified Charitable Distributions (QCDs). Once you're 70½, you can donate up to $100,000/year directly from your IRA to charity. This counts toward your RMD, isn't taxable income, and doesn't require itemizing. Excellent for those who donate and don't need full RMD income.
• Dynamic spending. Instead of rigid 4% withdrawals, adjust based on market performance. Reduce spending 10% after a down year, increase slightly after good years. Flexibility dramatically improves portfolio survival rates.
• Buckets strategy. Divide retirement savings into buckets: 1–2 years in cash (stable, accessible), 3–5 years in bonds (moderate growth, less volatile), 6+ years in stocks (growth, higher returns). Replenish buckets as they're used. This manages sequence of returns risk by ensuring you don't sell stocks during market downturns.

Common Mistakes

• Starting too late. Every decade you delay roughly doubles the monthly savings required to reach the same goal. Starting at 35 instead of 25 means saving 2x as much per month. At 45, it's 4x.
• Not capturing the full employer match. Leaving employer 401(k) match on the table is literally refusing free money. A 3% match is a 100% return on that 3% contribution. Always get the full match.
• Being too conservative with investments. Keeping retirement savings in cash or bonds in your 20s and 30s is a guaranteed way to fall short. You need stock growth to outpace inflation and reach your goals.
• Ignoring fees. A 1% fee on a $500,000 portfolio costs $5,000/year—every year. Over 30 years, that compounds to hundreds of thousands in lost growth. Use low-cost index funds and understand exactly what you're paying.
• Not having a withdrawal strategy. Drawing money randomly from accounts in retirement can create unnecessary tax bills. Order matters: taxable first, then traditional, then Roth. Plan withdrawals strategically.
• Underestimating healthcare costs. Medicare doesn't cover everything. Long-term care, dental, vision, hearing aids, and many medications are out-of-pocket. Budget $300,000–$600,000 per couple for healthcare in retirement.
• Claiming Social Security too early. Claiming at 62 instead of 67 reduces benefits by about 30%—permanently. If you live into your 80s, delaying almost always pays off. Unless you need the income or have health issues, consider waiting.

Action Steps

Quick Reference

401(k)

Employer-sponsored retirement account. 2025 contribution limit: $23,500 ($31,000 if age 50+). Pre-tax contributions reduce current taxable income; withdrawals in retirement are taxed.

Traditional IRA

Individual retirement account you open yourself. 2025 contribution limit: $7,000 ($8,000 if age 50+). Contributions may be tax-deductible; growth is tax-deferred; withdrawals in retirement are taxed.

Roth IRA

Contributions are after-tax (no deduction now), but growth and withdrawals in retirement are tax-free. 2025 income limits: phase-out starts at $150,000 single / $236,000 married. No RMDs in your lifetime.

4% Rule

A guideline suggesting you can withdraw 4% of your portfolio in year one of retirement, adjusting for inflation annually, with high probability of not running out over 30 years. Based on historical market data.

RMD (Required Minimum Distribution)

The amount you must withdraw annually from traditional 401(k)s and IRAs starting at age 73 (as of 2023). Calculated based on life expectancy tables. Failure to take RMDs results in a 25% penalty on the amount not withdrawn.

Full Retirement Age (FRA)

The age when you receive 100% of your calculated Social Security benefit. Currently 66–67 depending on birth year. Claim earlier (62) and benefits are reduced; claim later (up to 70) and benefits increase.