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You just found out that your 401k from work isn’t all it’s cracked up to be – if you're lucky to have one.
You may be wondering how you can plan for your retirement, or if it’s even attainable for regular people anymore.
Our parents may have been able to rely on programs that were truly beneficial when they were young, but for the rest of us, the retirement game is changing.
We’ve got some good news: there’s hope. If you can stick to a good strategy and work on some money habits, you can prepare for retirement, even if you’re older or don’t make the most money.
Today we’re not only going to break down how to prepare for retirement from start to finish, but we’re going to get you ahead of the curve, and help you calculate your exact plan for retirement!
What is Retirement? Is it Really Possible for Me?
If you’re able to change some habits and stay dedicated to improving yourself, you will be able to create a better future for yourself.
This is true both in personal finance, and other areas of life.
Even if you have debt, even if you don’t make a lot of money, even if you’re over 50 years old, you can still take steps now that can definitely improve your financial future.
It all hinges on choosing to make the best choices you can with what you have, and sticking to those choices, even when it's hard.
Retirement used to mean that when you hit a certain age (55 on paper, sometimes later), both the 401k provided by your employer, and your government-issued Social Security benefits would kick in and you could afford to stop working.
Retirement as defined by the dated concept above, isn’t really the case anymore, for a few reasons:
- Social Security isn’t what it used to be
- We don’t usually stay at the same job for 40 years anymore
Because the “unspoken rules” of retirement are all changing, retirement is more and more dependent on making wise choices leveraging the private sector.
We can’t rely on our government or employer for full retirement anymore.
It’s up to solely us to make sure we’re secure for the future.
Though this may seem like a mess of bad news, there is actually a helpful trade-off here:
Because we’re taking more control of our financial future, and leveraging different ways to create our retirement, it’s actually possible to retire earlier than 55 – and on your own terms rather than theirs!
Also, if you prefer watching instead, check out my video on this topic below!
Enter: Financial Independence
While the older concept of retirement is tied to ‘finishing’ working at usually one job after a long period of time, financial independence is a personalized goal that determines exactly when you don’t need to work anymore.
Simply put, financial independence is the total amount of money you need to earn in your lifetime in order to cover all of your life’s expenses.
Financial independence is somewhat separated from your age, and with the right strategy, it’s possible to have more control of what age you can actually stop working.
Generally speaking, you can stop working when you can afford to pay your expenses without using active income (jobs, actively managed businesses, etc).
While this all sounds exciting, the main thing to remember with both financial independence and retirement is the mindset of staying committed to making healthy, educated choices with your finances.
What Are My Options for Paying for Retirement?
As with everything in personal finance, being diversified is key: being able to pull from several different sources of income allows you to never be controlled by just one.
When it comes to retirement, the three traditional income sources are personal savings, social security, and pensions.
Ideally, you’d want your retirement portfolio to be diversified with several different assets, including those three.
However, as we’ve hinted at before: if you’re younger, it’s probably not a good idea to expect social security programs to really benefit you.
Likewise, workplaces that offer pensions nowadays are few and far between.
Especially if you’re younger, and even if you’re not, it’s a sober practice to view the potential for social security income and pensions only as supplemental retirement income sources – a bonus, never your main resource.
Some Info About the State of Social Security and Pensions
- 40% of Americans of ages 60 and above are completely reliant on the social security program
- The social security trust fund is likely to run out around 2035
- When this happens, payments won’t completely halt, but will instead decrease by around 25%
- Pensions are mostly a liability for businesses, because they're a continual expense that doesn't provide further profit.
- Pensions can also dry up and are dependent on a payer to give them.
- Only 6.8% of just those Americans age 60+ are getting retirement income from personal savings, social security, and pensions
- Being reliant on fixed payouts like these are also extremely exposed to inflation. $1200 doesn’t go as far as it used to.
Personal Savings as a Vehicle for Retirement
In today’s economy, personal savings is where you have the most control over your future.
Luckily for us, even though we might not have access to social security or pensions for our retirement portfolio, there are ample ways for us to diversify inside our personal savings.
When Do I Need to Start Saving For Retirement?
If you haven't, you should start right now. If not today, then this week. As soon as humanly possible.
In order for your retirement savings to grow, it requires a large amount of time. The two factors in creating abundance in your retirement fund are time and money.
Through the power of compound interest, you can actually afford to save using much less money if you start saving way ahead of time.
For example, it's easier to become a millionaire than you might think when you use compound interest correctly:
- With the average stock market returns, investing $300 per month over 40 years creates $1 million dollars
- Over the course of only 20 years, it would instead take an investment of $1750 per month to create $1 million – over 6 times the amount of money needed when investing over the course of 40 years!
Please understand – it's never too late to start improving your future. But if you wait to start saving and investing, it can really cost you.
Where Should My Retirement Savings Go?
Hopefully now we've got you shook enough to be asking yourself where to start.
Let's make sure all your bases are covered.
Some of the items on this list might not seem like they impact your retirement that much, but financial health at times certainly can mimic physical health:
If you were a bodybuilder and got a hernia, you wouldn't just keep doing your regular workout before making sure your body is healed – it would just cause you more harm. Everything is connected!
1. Emergency Fund
Before we start investing in the stock market, make sure you have an emergency fund.
This is 3-6 months of your total living expenses, saved in a regular old savings account. You only use this money for emergencies – car repairs, medical expenses, job loss, etc.
By having a solid emergency fund, you're able to avoid potential future debt.
2. Employer Matched 401(k)
If you're currently working a corporate job, you may have access to an employer-matched 401(k), where your employer pays into your retirement fund the same amount you do, up to a specific limit.
If you do have this, you want to only invest the maximum match amount.
When you do so, you're literally getting free money – and this adds up.
After you've maxed out your employer match, it's often better to invest your money in more aggressive options. However, this all depends on the quality of your 401(k).
3. High-Interest Debt
While the power of compound interest is amazing when it's working for you, it's also very effective working against you in the form of debt.
While you can expect some regular annual returns of around 8-12% from the stock market, most consumer debt rates range from 20-35%.
If you don't prioritize paying off these debts, they can really eat up your investment gains, and often take away even more money than you make off the stock market.
It's more important that you're able to “stop the bleeding” with those high-interest rates working against you first, rather than start building with investing.
This doesn't necessarily mean that you shouldn't start investing until you're 100% debt free, but it's very important to prioritize paying down large amounts of consumer debt before moving that cash into an investment vehicle.
Debt will keep you in chains and grows a lot faster than reliable investments can.
4. Individual Retirement Accounts (IRA's)
You've nipped your high-interest debt in the bud, maxed out on any employer matches you have available, and started to accumulate your emergency fund.
It's time to start looking at what IRA's (individual retirement accounts) can offer!
“What do IRA's actually do for me? How is this different from just investing in stocks?”
IRA's are great because they allow you to grow your money without being liable to the same taxation regular capital gains would.
The government essentially says “Hey, we see you're using the stock market to save for retirement, and we want to support that”, and treats the money placed in the IRA as special.
There are two major types of IRA's out there – Traditional and ‘Roth'.
Here are the main differences and features between each:
- Traditional IRA contributions can be written as a tax write-off, and have their standard withdrawals taxed as normal income.
- Roth IRA contributions cannot be written as a tax write-off, and do not have their standard withdrawals taxed if all rules are met.
- Both IRA types have a maximum yearly contribution cap.
- Through both IRA types, you are able to save and grow money and bypass some taxes you otherwise would be paying.
Roth IRA's have different benefits, but also have several extra terms and conditions when compared to a traditional IRA.
5. Taxable Brokerage Accounts
Finally, when you've maxed out your IRA contributions, the rest of your contributions can go to a taxable brokerage account.
This is the same regular account someone makes when they decide to start investing in the stock market.
When you have all of your other ducks in a row, and are able to grow enough income through these brokerage accounts, you can afford to start withdrawing from them and retire early.
How Much Money Will I Need to Save For Retirement?
While everyone's situation is different, there's usually more than one correct answer for each individual.
The amount you will personally need for retirement is dependent on your lifestyle needs, and assets you will have when you retire.
- Do you want to live simply, and just get by?
- Do you plan on being a homeowner and having a mortgage paid off by the time you retire?
- Do you want to accomplish more of your dreams when you retire, such as seeing the world, or buying your dream car?
- The less money needed for your retirement lifestyle, the less you'll need to retire.
Fortunately there's a general equation that finance experts agree on that provides a good starting estimate: the 4% rule.
The 4% rule states that for each year of retirement, you should withdraw only 4% of your total savings (modified for inflation).
By doing so, you have a solid likelihood of having your retirement savings lasting around 30 years, which is a good estimation of how long you'd want your retirement fund to last.
While ‘overfunding' your retirement account can be fun for you later in life, on the flip side, having your retirement fund run dry can create some really bad scenarios.
These are the scenarios we want to avoid by planning ahead soberly.
To estimate your total savings required by the 4% rule, use the following formula:
- Take your desired annual retirement income level (I.E. $40,000)
- Multiply that amount by 25 (making the annual income 4% of the total – $40k x 25 = $1,000,000)
- The result you get is the general amount of retirement funds you'll need ($1,000,000).
If you want to be more conservative with your retirement, you can instead use the 3% rule – withdrawing only 3% of your retirement fund each year to live off of.
Back-Up Plans and Retirement Hacks
Let's say your situation is less than ideal.
Maybe you have more debt than you'd like, or can't seem to find enough margin in your current finances to save or invest enough money.
Maybe you've been reading this article dead certain that you don't have enough time.
Below, we've listed some doubts you might have about personal situations, and provided some different strategies to overcome and make the best of what you've got.
What if I Can’t Save Enough for Retirement?
For a second, think about retirement like a long road trip.
You've got a certain amount of gas in the tank, but you'll need to ration it out to get to your vacation destination.
One option you can take is to be very strict with your gas mileage, the roads and detours you take, etc.
A different option you can take is to just go and put more gas in the tank!
There are multiple strategies to getting the most out of your retirement situation, even when you're behind.
Try to utilize several of the following strategies in tandem with each other for greater retirement success!
1. Make More Money
Sometimes, the idea of budgeting and ‘tightening the belt' further sounds like a death sentence.
You should be budgeting, absolutely, but making more money is one of the best ways to find more margin for your financial goals.
See if you can start a small side hustle to help bridge the gap. Usually, even just a small amount of margin in your financial outlook can really help not only your retirement, but quality of life as well!
2. Spend Less Now
Another tried and true method of improving your retirement savings is simply budgeting and finding areas you can afford to cut back on.
In the digital age of the 2020's, we often tend to hold on to several subscriptions we don't use as much as we could.
Even locating two of these subscriptions, canceling them and reinvesting that cash into an IRA could create some margin for your retirement.
3. Spend Less In Retirement
Work today towards creating a retirement lifestyle tomorrow that doesn't have a high overhead.
- Downsizing a house or vehicle
- Learning how to cultivate a home garden for homegrown food
- Finish paying your mortgage prior to retirement
Just as with creative budgeting for the short term, planning ahead to create a retirement lifestyle that can thrive on a budget is doable – with some innovation and planning.
4. Delay Your Retirement
Finally, delaying your retirement is another option to make your savings last.
This option is a bit of a “Plan C” rather than a “Plan B”, and should only be considered after the above options have been tried.
Though delaying retirement may sound like the worst, there are a few upsides to doing so when you need to!
By delaying retirement, you obviously have more time to let your money grow, and more annual cycles to save money.
Additionally, your social security checks get a bonus because you deferred the payments.
How Long Will My Money Last?
Generally speaking, your retirement funds' growth depends on the kinds of investments they are comprised of.
When investing into riskier stock portfolios, you stand to gain more growth, sometimes at a rate of return of even 12-15%, at the risk of more loss.
On the flip side, this same “risky growth”is what gives your retirement fund the ability to last – if you're only investing in say, bonds with only 5-6% return, you may not be growing your money enough for it to last for 30 years or more.
The 120 Rule of Thumb
Another measuring tool for estimating your retirement spread is the rule of 120.
How it works is, you'll subtract your age from the number 120.
The result that you get is the percentage of your investment portfolio that should be given to stocks – the remainder should go into bonds.
- Let's say you're 25 years old
- 120-25 = 95
- 95% of your investments should be in stocks
- 5% should be in bonds
Earlier in life you'll want to invest more aggressively to obtain more growth, because you don't have that many assets yet.
This is when you want much more of your portfolio in stocks instead of bonds – though you should have a good spread in each.
Later on in life, you'll usually have more assets on hand that you still want to grow, but also want to protect from market exposure.
This is when you'll start putting your assets into more defensive investments, trading your higher rates of return for less risk, often in the form of bonds.
You'll still want to have a good portion invested into both stocks and bonds for a healthy, diversified portfolio that both grows and is resistant to risk.
Another big factor to the lasting health of your retirement fund is taxes.
With different retirement vehicles such as Roth IRAs, you aren't taxed on your retirement withdrawals when you follow their rules.
Taxes can have a large impact on your retirement fund – getting a one-time consultation from a financial advisor can be very helpful in navigating your specific situation concerning both taxes, and your retirement funds' lifespan.
How Can I Make My Savings Last Longer?
Let's say you have a shortfall in your retirement savings, and you're getting older.
While some of your options may be less than ideal, you still have some ways to offset the shortfall.
One great way is to consider downsizing – you may have paid off a full mortgage or a big house that you don't fully utilize anymore.
Instead of continuing to pay for maintenance on the full house, you could sell the property for a smaller house, with lower heating, utilities, and upkeep costs.
Alternatively, you could use a website like Airbnb to rent the rooms you're not using, creating a passive income stream to support your retirement fund.
Another way to stretch your income out is to delay social security payments – for every year you wait to receive your benefits, you accrue an 8% bonus, up to 24%.
Maybe those points aren't the most applicable to your situation, but the underlying principle can definitely help your outlook:
The main way to make your savings last longer is to plan your retirement lifestyle's budget ahead of time.
By looking at your future retirement income, and creating a budget for your lifestyle inside those retirement means, you can manage to find some healthy margin and ways to make it work.
By reducing your fixed expenses, paying off loans, cars, housing payments, getting rid of subscriptions, you can create a situation for yourself where you have enough to thrive.
Another bonus tip: Consider responsibly using credit cards to gain credit card rewards towards free travel points.
What if I Fall Short? What if it Isn’t Enough?
We've all felt that gripping dread that only finances bring out of us.
When it comes to your retirement fund, luckily, if something starts to turn for the worse, you should be able to see it coming, and react accordingly.
A lot of the strategies we've mentioned prior including reducing expenses and part-time gigs very much apply here.
If you've become a homeowner, you may have the option to take out a home equity loan, or a reverse mortgage.
Likewise, if you have a ‘whole life' life insurance policy, you may be able to tap into the cash value of your insurance.
With shortfalls like these, the later you choose to address the problem, the worse it will end up.
Do I Need to Work With a Financial Advisor?
Financial advisors can be really helpful, especially if your personal situation seems complicated.
You don't absolutely need to hire a financial advisor to retire well, but they never hurt (so long as they're not overcharging you)!
It is certainly not a bad investment to pay a few hundred dollars to find a fee-only hourly CFP who can give you their professional experience.
While we can only help you by providing general advice based on financial principles, a good financial advisor can work with your exact situation to help figure out the exact strategy that will work for you.
After reviewing all of your personal details and goals for retirement, a good financial advisor will be able to identify underlying problems and solutions for your retirement and personal financial health.
“If you fail to plan, you are planning to fail.” – Benjamin Franklin
If you take anything away from this article, understand that planning ahead and staying committed to making small, informed changes to your lifestyle can drastically improve it over the long run.
You are worth it to take care of yourself, financially and holistically.
Take the extra time and consideration to figure this out.
If you need more resources on learning the ins and outs of finance, click here for some great tips on how to win the game of money!