Traditional retirement planning has always relied on the “three-legged stool” of retirement income sources: a defined benefit pension plan, Social Security, and a 60/40 stock/bond investment account. Over the past two to three decades, the first leg of the stool has all but disappeared as many defined benefit plans have been replaced with defined contribution 401(k) or 403(b) plans. These types of plans place the burden directly on the individual to create a sustainable income source. This, coupled with greater market volatility, has forced us to rethink the traditional retirement paradigm. Here are four essential elements of a sound retirement plan for the 21st century.

Set Clearly Defined Goals

Thanks to advances in medicine and technology, life expectancies are longer than ever. However, longer life expectancy creates a new challenge for retirement planners: longevity risk, or the risk of outliving one’s assets. For this reason, it is important to establish a clear vision of what the future holds.

• Do you plan on fully retiring or continuing to work part-time?
• Will you make any changes to your lifestyle in retirement?
• Where will you live?
• What would you like to accomplish during retirement, and what would you like to leave your family?

Answering these questions helps to lay the blueprint for an investment strategy.  For example, an individual who wants to leave a legacy to his heirs may be willing to invest more aggressively than an individual who plans to draw monthly income from her portfolio.

Calculate Retirement Costs

A popular rule of thumb suggests that retirees will spend 70% - 80% of their pre-retirement income to maintain the same standard of living. On the surface, this makes sense; a large percentage of our incomes is spent on items related to work (especially gas and auto maintenance), and an individual no longer working should expect to cut these expenses. The major flaw with this rule is that it does not account for inflation nor increasing costs of healthcare. Planning for retirement must now include contingencies for healthcare costs and other unexpected expenses.

Develop a Long Term Investment Strategy

The first step in establishing an investment strategy is determining an individual’s personal tolerance for risk. Some people can watch a 10% market decline without panicking while others get nervous after a drop of just 2%. While there is no “wrong” answer, it is extremely important that individuals understand their personal risk tolerance when developing an investment plan.

The second step is to merge retirement objectives with risk tolerance to establish a long-term investment strategy that can reasonably be expected to achieve one’s goals. This is accomplished through diversification across several asset classes and investment vehicles.

Investing is an art rather than an exact science; changes to the strategy will be required, but a sound foundation helps to make the process rational rather than emotional.

Manage Tax Liabilities

Another shortfall of the traditional retirement paradigm is that all three income sources shared similar tax treatment. Pension income, 401(k) withdrawals, and investment dividends are all treated as ordinary income under IRS rules. By including other income sources like a Roth IRA, and effectively managing one’s capital gains/losses year-to-year, one can minimize the tax burden and help make every income stream last a little bit longer.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2015 Advisor Websites.