The topic of retirement comes up all of the time on the news, in the newspapers and magazines and in personal finance blogs. With so many different people talking about retirement, it not only gets confusing, it can also get overwhelming. Luckily, I am here to help. I will give you the guide to making sure you can retire. What we waiting for, let’s get started.
Step 1: Define Retirement
This is the crucial first step that you have to take. Spend some time writing down how you envision your retirement. Will you be playing golf all of the time? Traveling? Working part-time? Moving to Florida? While you don’t need to know exactly everything you want to do in retirement, you need to have some sort of idea here. You also need to know at what age you plan on retiring as well.
For me, I write all of the things down that I want to do in retirement. I do this so I can go back and change things up. Nothing is set in stone. Maybe you love photography now, but in 10 years realize you want to learn how to paint and would love to paint in retirement. This is fine. By writing things down, you have a record of everything.
Also, when completing this step, don’t limit yourself to 15 minutes of thinking and writing. Take a few weeks to really think things through before moving to step 2. You need to be honest with yourself and your dreams. Take the time necessary to do this.
Step 2: Figure Out How Much Money You Will Need
This is probably the most difficult step in the process. There are all sorts of numbers thrown around, but a good bet is the 8x rule. This rule says that you should have saved 8 times your salary when you plan to retire. So if you make $100,000 per year, you need 8 times this, or $800,000.
For me, I am conservative in nature when planning things. To me, there are all sorts of things that could go wrong and at the end of the day, I’d rather die with $100,000 in the bank than be flat broke at 85 and live another 10 years. So for me, I use the 12x rule. It’s the same as above, just 12 times instead of 8. So for a salary of $100,000 I would need $1.2 million saved.
(Another approach is using your expenses instead of your salary and calculating your needs based on the 25x yearly expense multiplier.)
Note that I am not taking into account Social Security in these numbers. I expect to receive Social Security, but since I don’t know if the age limit will be raised or benefits cut by the time I retire, I just don’t factor it in. Whatever I get will be treated like a bonus.
Step 3: Assess Your Current Situation
Let’s say you need $800,000 and you plan to retire at 65 and are currently 45 years old. If you only have $25,000 saved for retirement, you are going to need to do some serious savings over the next 20 years. You will need to save about $14,000 per year, assuming an 8% annual return to reach your goal.
Since most Americans are saving nowhere near as much as they should for retirement, chances are your savings are underfunded too. If this is the case, you need to make some changes. Either start saving more now, change when you plan on retiring, or change how you envision your retirement. Those are really your three options.
Since I would rather keep my dreams alive, I would make some changes now. Find ways to increase your income while at the same time decreasing your expenses. If you do both, you should be able to make up the amount that you are short. Depending on your age, you can also take advantage of retirement catch-up contributions.
Step 4: Get Everything Lined Up
As you near retirement, you need to make sure you have other things in order. This includes insurance coverage, specifically health insurance, and to make sure you have all of your debts paid off, including your mortgage.
When it comes to your mortgage, here is why it is so important to get that paid off before you retire. If your monthly payment is $800 per month (just principal and interest), that is close to $10,000 a year. By having it paid off, you just freed up $10,000 in retirement! This will benefit you if you are behind on your savings goal because you will have freed up some extra money.
The same idea applies for other debts too including credit card and auto loans. Here is a helpful Retirement Planning Checklist with many more tasks to complete before retiring.
Step 5: Review Your Investments
In reality, you should be doing this all the time but I wanted to talk about it separately. As you age, you should be changing up your asset allocation to a more conservative mix. However, be careful that you don’t become too risk-adverse. Many investors think that once they reach retirement, they need 100% of their investments in bonds. This might have worked 30 years ago, but not any longer.
The reason for this is because we are living longer and longer. Back then, you could get by with 100% bonds because you were only expected to live another 10 years. Now that we are living into our 90s, we need the growth from stocks to keep us from running out of money.
Also, as we have recently seen, we might need the higher income (dividend) payments from stocks when interest rates are low. In order to survive financially in retirement you need to go as long as possible before dipping into your principal. The only ways to do this is to get a decent yield on your money or get a decent return.
So there are the 5 steps to follow to ensure you retire. Not too complicated right? The first step will certainly take you the longest to complete. From there, it is all about making sure you are saving enough. As time goes on, you may lose some interest in saving for a goal that is 10 years or more away. If this is the case, refer back to your goals from step 1. This will help you stay motivated to keep saving as much as you can so your retirement dreams become a reality.
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