A 401(k) may be the first thing that comes to mind when you think of funding your retirement. However, your 401(k) is just one of many tools you’ll lean on to generate income in retirement. Diversifying your sources of income in retirement can significantly reduce your exposure to common financial risks, but it can also add additional complexity to your finances. That’s why it’s important to build a retirement plan — in addition to saving for retirement.

What is a retirement plan?

In its simplest form, a retirement plan is a roadmap to reliably and efficiently generate income to support your lifestyle in retirement and your legacy, if you have a goal to leave one. It will help manage retirement risks such as market volatility, rising costs, increasing taxes, unknown healthcare needs and longevity. With a solid retirement plan, you can worry less about these risks and focus on enjoying life.

How does a retirement plan work?

By the time you reach retirement, you’ve probably tucked savings into a variety of accounts, such as a 401(k), traditional and Roth IRA, a regular brokerage account, health savings accounts, as well as pensions, annuities, and the cash value you may have accumulated in a whole life insurance policy. Your Social Security and Medicare benefits will also kick in to provide an additional cushion in retirement. You’ve got the orchestra, but you need a conductor to ensure they’re all playing together in harmony. That’s the role of a retirement plan and a financial advisor.

Ultimately, your plan will help you reliably generate income to support your lifestyle in retirement. However, there are a few key areas where a solid retirement plan can help you get the most out of your savings.

Tax efficiency

An effective retirement income plan aims to reduce your tax liability. When you take distributions from tax-deferred retirement accounts, such as traditional IRAs and 401(k)s, those distributions will be taxed as ordinary income in retirement (the opposite is true for a Roth IRA). That means a chunk of your nest egg will be rerouted to the IRS. Strategic planning can balance your income needs so that you’re relying on a mix of taxable and non-taxable accounts. This is key as withdrawing too much could inadvertently push you into a higher tax bracket, which will eat into your savings even more.

Keep in mind that you’ll have to begin tapping your tax-deferred accounts sooner or later. You’ll be on the hook for required minimum distributions (RMDs) beginning at age 72, but an experienced financial advisor can help you balance these withdrawals with other income sources.

Market volatility

It’s wise to manage your retirement income in a way that uses market volatility to your advantage. Selling investments when the market is rising can generate extra income you can then funnel into your savings account. In this way, some exposure to markets in a retirement portfolio can help your savings stay ahead of inflation.

When the market dips, you can rely more on cash reserves or money you’ve accumulated in a whole life insurance policy until things rebound.

Health issues

Even with Medicare, which begins at age 65, you’ll still need to plan for regular health care costs. This includes everything from deductibles to premiums to prescription drugs and more. You’ll likely encounter steeper costs if you or your spouse develop a serious illness that requires long-term care. Those who live to 65 have a 70 percent chance of needing long-term care at some point, according to the Department of Health and Human Services.

It’s something that could significantly impact your nest egg, but it can be planned for based on reasonable projections about the future.

Hedging longevity risk

While the 4 percent rule has long been a rule of thumb, many experts are now recommending more conservative numbers to prevent outliving your money — 2 to 3 percent may be more appropriate given the low interest rate environment and elevated stock market valuations. This is just a rule of thumb, and you’ll want to devise a more comprehensive strategy that suits your preferences. Still, the bottom line is this: There are strategies to reduce this common retirement risk.

The current life expectancy in the U.S. is just shy of 78 years old, according to the CDC. But you could very well live longer; a good problem to have, but a problem nonetheless.

Legacy planning

Most of us will leave something behind at the end of our lives. Being purposeful about it now can ensure that your loved ones are taken care of. Planning allows you to be intentional so that you don’t end up drawing on assets you’d prefer to pass on to the next generation, and even leave a larger legacy behind. It hints at the importance of having a drawdown plan that will last a lifetime.

What is a retirement plan? It boils down to generating retirement income in a way that protects your financial stability over the long term. The right financial advisor can help you create a customized plan that’s built to help you create the retirement you envision.

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