Having the ability to retire, at any age, is a huge accomplishment. But, how do you know when you are ready? What do you need to do to make sure you have the ability to retire? Below are the financial milestones you must reach before retiring.
Retirement (financial independence) means that you no longer require a paycheck to support your lifestyle. However, being ready for retirement is more than having a large nest egg. You need good financial habits and a solid plan.
What age will you retire?
The first thing you need to do before you retire is to determine when to retire. Knowing what age you will retire is really important because this determines the amount of time you have to accumulate wealth.
Determining your retirement age might seem like an easy question, but there is actually a lot to think about here. Some might be thinking, I want to retire as soon as possible. While others are thinking, I will never retire. Many of us are somewhere in the middle.
If you are 20 and want to retire when you are 70, you have a lot of time to build wealth – 50 years worth of time. Individuals in this group do not need to be overly aggressive in their savings because their money has time to grow. However, just because the time horizon is 50 years does not mean you do not need to save. The longer you wait to save, the more aggressive you will need to be with your savings later in life. When it comes to investing, time is your best friend – don’t waste it, you never get time back.
Do you want to retire early – or have the option of retiring early? The ability to retire (at any age) depends on your savings rate. The more you save and lower the cost of your lifestyle, the faster you will reach financial independence. Early retirement (or the ability to retire early) requires a lot of self discipline and perseverance, and it is very possible.
Regardless of what you want, sometimes life has other plans. Its really important to start saving as much as possible, as early as possible. You just never know what will happen.
For instance, what happens if you have a health condition that prevents you from working? You may want to retire at 70 (or later) but what if you need to cut your wealth accumulation by 10 years? 20 years? Hope for the best, plan for the worst. The best retirement plan is to save early and aggressive.
If you would like to learn more about what age you can retire click here.
Determine your FI Number
The second thing you need to do before you retire is to figure out how much money you need. Figuring this out sounds really complex and overwhelming. There are so many what-ifs. Life is uncertain and predicting what you need decades into the future is difficult.
However, the basic rule of thumb is to save 25x your estimated annual spending.
To determine your retirement number consider the following:
- Housing costs – Will you have a mortgage? Will you be renting? Are you going to practice geo-arbitrage?
- Health Care – How much is health care going to cost? This includes medical, dental, and vision. What is your plan during a health emergency?
- Traveling – Do you want to travel? What type of travel will you be doing (basic vs. luxury)
- Food – How do you want to eat? Rice and beans or organic (or somewhere in between)? Do you like to go out to restaurants or cook at home?
- Other Fun expenses – Do you like to go to the Theater? Do you like to go to sports games? Build into your budget miscellaneous fun expenses.
If you are interested in learning more about how you can find out what your retirement number is, check out my step-by-step guide here.
Savings Withdrawal Rate
Your Financial Independence number and safe withdrawal rate go hand-in-hand. How much you can safely withdraw from your nest egg without having to worry about running out of money?
The well-known and highly accepted Trinity Study (also known as the 4% rule) determined that the safe withdrawal rate is 4% of your portfolio each year.
How was this determined?
Three professors performed research on the stock market performance covering the period 1925 through 1995. They determined that a person could withdraw 4% of their portfolio each year in in retirement and not run out of money. Since the study included the stock market performance during the Great Depression, this means, the 4% holds true even during the worst recession in history.
Taking this a step further, the 4% is based on the portfolio during the first year of retirement. This means, if you during your first year of retirement, your portfolio is $1.5M, then you can safely withdraw $60,000 per year.
For those wanting to retire early, since the time horizon can be decades longer than a traditional retirement, the 4% rule requires a little more flexibility (but not much). For instance, depending on the strength of the market, the 4% rule varies during recessions and expansions. During recessions, you should plan to withdraw about 3.5% and during expansions you can withdraw closer to 4.5% – 5%. With a $1.5M portfolio, this means you can safely withdraw $52,500 during recessions and up to $75,000 during economic expansions.
Also, remember this, if the economy performs better than the Great Depression, you are highly likely to end up actually making money!
Before you retire, you need to know how to live on a budget. Remember, retirement means you are on a fixed income. Knowing how to create and stick to a budget is incredibly important if you are planning to quit your job with no money coming in.
As mentioned above, there are some big expenses that need to be considered when determining your Financial Independence (Retirement) number. These big expenses play an important part in creating your budget. Below is a breakdown of important considerations you need to know when determining how much to save and how much to spend.
Health Care Costs
One of the most important considerations when budgeting during retirement includes health care costs.
Todays health care is most likely not going to be the same 5 years from now, 10 years from now.
To put this into perspective, a research study revealed that a 65 year old woman should expect to pay a between $3,300 – $7,700 out-of-pocket medical bills annually. This is the amount not covered by insurance, medicare, or medicaid. Your costs could go up based on chronic underlying heath conditions such as high blood pressure, asthma, and diabetes. Those who smoke generally spend a lot more on health care costs because they have a higher rate of chronic illnesses.
That’s just for the routine medical care each of us needs every year. However, long-term care facilities (e.g. nursing homes and assisted living) cost a lot more. As of 2020, long-term care is likely to cost you upwards of $250,000 or more. The monthly costs often exceed $8,000. Before you retire, look into long-term care insurance.
There is no doubt about it, health care costs are very likely your biggest and most unpredictable expense.
With your new-found freedom, you may want to travel the world. If you plan to travel extensively during retirement, make sure you include travel expenses in your yearly budget.
Ask yourself what kinds of accommodations you want during your travels. Is a simple Airbnb all you need? Would you be ok at a budget hotel or hostel? Or do you want more comfortable hotel accommodations.
Will you travel on your own or will you want to make things easy and be on a guided tour?
Where will you travel? Not all areas of the world are equal in terms of travel costs. For instance, an African safari is likely to cost you at least $10,000 per person.
Will you be responsible for a mortgage in your retirement years? How much of your monthly and yearly budget does the mortgage payment comprise?
One financial milestone you must reach before retiring is paying off any high-interest debt. This mostly consists of credit card debt, but it could also be other types of loans such as pay day loans. If you have any debt over 4%, then pay it off BEFORE you retire. You do not want this following you in your golden years.
Next on the list of financial milestones before retiring includes deciding what you will do about social security.
When should you claim Social Security?
When you want to receive social security and when you should receive social security can be different.
You may want to receive social security as soon as you can, which as of 2020, is 62 years old. However, if you wait until you are 70 years old, you will receive a larger sum.
Social Security benefits mainly depend on the year you were born and your income prior to retirement.
For instance, if you were born in 1944 then your full retirement age is 66. However, if you were born in 1960, then your full retirement age is 67.
Let’s take this a step further.
Say you are born in 1944. Your monthly benefits at the full retirement (age 66) is $1,000. How much social security would you receive if you decide to claim your benefits at age 62? You would end up receiving $750 per month.
Say you are born in 1960. Your monthly benefits at full retirement age (age 67) is $1,000. How much social security would you receive if you decided to claim your benefits at age 62? You would end up receiving $700 per month.
When you should claim social security is highly dependent on how long you expect to live. If you do not expect to live much past your full retirement age its better to claim social security as soon as you can at the lower rate.
However, if you anticipate living into your 90s then it might be worth waiting a few extra years to get the full benefits.
For more information check out the SSA website here.
How much will you rely on Social Security?
How much you depend on Social Security is highly correlated with how much you saved during your accumulation (working) years.
Social Security is only supposed to cover 40% of your retirement. The remaining 60% is your responsibility.
Whether this is actually true depends solely on you.
If you were (are) an aggressive saver, then you are likely to not rely on Social Security very much. However, if you did not save, and depend on Social Security as part of your retirement plan, then, you will rely on these benefits greatly.
Understanding how much you will rely on Social Security is one of the financial milestones you must reach before retiring.
Another one of the financial milestones you must reach before retiring is having a solid emergency fund.
Before you leave your job, make sure you have between 6 months to 1 year of cash saved up.
The first 5 years of retirement are going to determine a lot about how the rest of your retirement is going to look. If you end up retiring during a market recession, you are most likely going to want to hold off on making any withdrawals from your portfolio as long as you can. Having 6 months – 1 year of cash on hand will help you ride the wave.
Review your Will
Before you retire, have a plan in place for what happens if and when you die. It’s morbid and a bit depressing to think about but it is necessary.
Make sure you periodically review and update/renew your will. You will need to update your will every 3 – 5 years.
Your asset allocation is what you are invested in. This can be composed of Real Estate, Stocks, Bonds, or some other financial instrument.
Make sure you are comfortable with your asset allocation.
For instance, stocks are much more volatile than bonds. Their ups and downs are bigger than the ups and downs of bonds. Make sure, whatever your asset allocation, that you are comfortable leaving things as-is if the market takes a tumble.
For instance, if you are 100% in stocks, how would you feel if your portfolio went down by 25% and you had no other income to rely on?
Bonds help smooth the ride.
Real estate can go up, can go down, and can require a lot of repairs and maintenance. You may get steady cash flow, but you will need to determine whether this sort of investment fits with the lifestyle you want to have.
Having the ability to retire is an amazing accomplishment. It is not easy to achieve, requires a great amount of planning and self-discipline. Make sure to follow the financial milestones you must reach before retiring to help your transition into retirement be successful!