How to Retire: Must-Know Steps to Prepare for Life After Work
By Crystal Lee
| Last updated
Figuring out how to retire is a top priority for many working Americans who dream of a future that is free of deadlines and responsibilities. But there are so many questions to ponder: How much money will you really need? Will Social Security be enough to carry you through? What if you want to walk away from your job by the time you're 50 or 60?
This article has the answers you need. It explains how you can assess your income and expenses and calculate the approximate amount of money you'll need for a comfortable retirement. It also offers detailed strategies on how to successfully exit the workforce at different ages, from 50 to 62. And it includes tips on how you can retire even if you don't have much in the way of savings.
Here's the reality: Despite some negative stories in the mass media, most retirees find retirement to be less financially challenging than they expected. In fact, 16 years of annual surveys by polling organization Gallup have consistently found that more than 70 percent of retirees report having enough financial resources to live comfortably. In 2018, that number was 78 percent.1
So read on to get the information you need in order to reach your retirement goals!
How Much Money Do You Need to Retire?
As they approach the end of their time in the workforce, the question at the top of most people's minds is: "Will I have enough to retire?" After all, you could potentially be retired for 20 or 30 years—or even longer. So it's crucial to ensure that you have enough financial resources to meet your needs.
So, how much money do you need to retire comfortably? Because everyone has different needs and priorities, there isn't just one right answer to that question. It depends on how much you spend and how long you live.
Here's how to figure out how much you need to save for retirement:
Take a percentage of your income.
A generally accepted guideline is that a person needs 70 to 80 percent of his or her preretirement income in order to cover post-employment costs. So, for example, you may ask, "If I earn $55,000 annually, how much money do I need to retire at 65?" Using the 70-to-80-percent rule, you need an income of $38,500 to $44,000 per year to retire. That means in order to fund a 20-year retirement, you would need assets totaling between $770,000 and $880,000. And if you retired earlier or lived longer and needed your savings to stretch for 30 years, you'd require anywhere from $1.16 million to $1.32 million.
Obviously, the amount you need will depend on your particular situation. If you currently spend 90 percent of your paycheck on basic necessities like rent and food, you will probably need to replace more than 80 percent of your working income in order to maintain your standard of living. On the other hand, if you've been devoting 30 percent of your income to paying down your mortgage and you get the balance paid off before you retire, you could potentially live comfortably on less than 70 percent of your preretirement earnings.
Keep in mind that not all of your funds have to come from your savings and investments. If you qualify for Social Security benefits, or if you have rental income or a pension, these can all factor into your retirement income.
Calculate your projected expenses.
A widely accepted way to determine the amount you'll need is to calculate your annual expenses and multiply them by 25. By this logic, if you spend $35,000 each year, you'll need to save $875,000. This ties in to what is known as the four-percent rule, which holds that you should be able to safely withdraw four percent of your savings in each year of retirement (adjusting for inflation) without a significant risk of running out of cash in 30 years. However, the four-percent rule doesn't work in all situations. For instance, it assumes a certain balance of stocks and bonds and doesn't account for taxes, investment fees, or lower-than-normal market returns. But historically, it has been shown to be effective.
To determine your spending needs in retirement, take some time to honestly reflect on what you would like to do and what your lifestyle will cost. For example, do you plan to indulge in senior travel? Will you go back to school or take up a new hobby? Are you aiming to help fund your grandchildren's education? These are all factors you need to consider.
In some ways, your expenses should decrease when you retire. After all, you won't be spending money on work clothes or commuting costs, your mortgage may be paid off, your children may have left the nest, you won't be saving for retirement, and you will likely drop into a lower income tax bracket. However, other costs could rise. For instance, you will probably spend more on leisure activities and healthcare. And as time goes by, inflation will make everything you buy more expensive.
To get a better idea of what your needs will cost, think about:
- Housing—rent or mortgage payments, property tax, homeowners or tenants insurance, utilities, and upkeep
- Transportation—vehicle payments, fuel, parking, insurance, and maintenance
- Food—groceries as well as restaurant meals
- Healthcare—health insurance premiums and treatment costs
- Travel, entertainment, and leisure
- Taxes and insurance—senior life insurance, IRA and 401(k) withdrawal taxes, pension taxes
One study found that, overall, average household spending dropped by 7.7 percent in the first two years of retirement. Transportation costs had the biggest decrease at 25 percent. Interestingly, the same study revealed that almost half of retirees end up spending more in the first few years of retirement than they did while they were working.2 In any case, it's always better to budget for more if you can.
Use an online retirement savings calculator.
Are you still asking yourself, "Have I saved enough? Can I retire?" Calculator tools can be a convenient way to get a general sense of how much you need to save for retirement and determine if you're on track to meet your goals. You can even play around with different scenarios to see how you could adapt your strategy. Keep in mind that it's wise to consult a professional financial planner in order to get advice tailored to your specific circumstances. But if you're looking for an easy retirement calculator to try out on your own, here are a few free options:
How to Retire Early
As long as you have the financial means to support yourself, you can retire at any age. Advocates of the FIRE (Financial Independence, Retire Early) movement insist that you can retire at age 40 or even earlier; some of them live so frugally that they save 75 percent of their income and end up retiring as millionaires in their 30s. While that's unrealistic for most people, it is possible to say goodbye to your job before you reach your mid-60s. Here are some steps you need to take to plan for retirement ahead of the traditional schedule:
Start saving as early as possible.
The most important step in learning how to retire young (or for that matter, learning how to retire rich) is to start socking away your money as soon as you can. In a perfect world, you should start saving for retirement as early as your 20s. After all, the longer you can let interest compound, the better off you will be. So if you're planning to retire early, you should really get a jump on your saving.
The standard recommendation is to save 10 to 15 percent of your paycheck in order to be ready to retire in your 60s. But if you can manage to put aside 20 percent or more of your paycheck beginning at age 20, you could potentially be in a comfortable position to retire as early as age 50. Think about it: If you invest $10,000 each year and earn an average return of eight percent, you will end up with a nest egg of $1.2 million after 30 years. Be sure to dedicate a chunk of your portfolio to growth so that you can maintain your purchasing power amid inflation.
Get out of debt.
Debt payments cut into your cash flow and reduce the amount of money you can save and invest. Car loans and credit card debt often come with high interest rates and should be eliminated before you retire. Some people choose to forgo credit cards entirely and operate on a cash-only basis—that way, you can't spend money you don't have.
Paying off your mortgage is also a good move. Many retirees find it liberating to pay off their homes before they finish working. However, when interest rates are low, you might benefit more from putting extra money into retirement accounts that invest in stocks or bonds. Check with your financial advisor to see what option would work best for you.
Put money in tax-advantaged investments.
If your employer offers a 401(k) plan, be sure to max out your contributions. In a 401(k), up to $18,500 can be saved for retirement each year if you are under 50; if you're over 50, you can throw in an additional $6,000. Doing so allows you to lower your taxable income, and the capital gains and dividends earned inside the plan are not taxed until you withdraw the funds (presumably in retirement, when you will likely be in a lower tax bracket).
Plus, many companies match a percentage of employee 401(k) contributions, meaning you get a chunk of free money for retirement. For example, suppose you earn $60,000 a year and your employer matches your savings up to six percent of your salary at a rate of 50 cents on the dollar. If you kick in just $300 a month, you'll get $1,800 in free cash from the company each year.
A traditional IRA (individual retirement account) also allows for tax-deferred investment growth. Anyone up to age 70.5 who has earned income can open an IRA. You are allowed to contribute up to $5,500 a year if you're under 50 and up to $6,500 a year if you're over 50. Your contributions grow tax-free and may be tax-deductible, depending on how much you earn and whether your (or your spouse's) employer offers a retirement plan. You will only be taxed on the money when you start making withdrawals. Note that you must begin taking withdrawals by age 70.5.
It's important to understand that with 401(k)s and traditional IRAs, there are penalties for taking out funds before the age of 59.5.
A Roth IRA is slightly different. Your income must be within certain limits to start this type of account. Plus, your contributions are taxed on the way in rather than on the way out. That means you get no break on your income tax when you contribute, but you pay no tax when you make a withdrawal. The important point for anyone looking to retire before age 60 is that you can withdraw your contributions from a Roth IRA (though not the earnings generated from them) at any time without penalty, even if you are under the age of 59.5.
You can have both a Roth IRA and a traditional IRA, but your total contributions for the year across all IRA accounts cannot be greater than $5,500 (or $6,500 if you're over 50).
Reducing your expenses has two major advantages: 1) It allows you to put more money toward retirement savings, and 2) it gets you accustomed to a lower-cost lifestyle, which you may be adopting in retirement anyway.
Housing will be one of your biggest retirement costs, so consider downsizing to a smaller home or moving to an area with a lower cost of living. You might also want to think about relocating to a state that does not tax personal income. (Just be aware of other tax implications: Texas, for example, has no income tax, but it does have some of the highest property tax rates in the country.)
Trim unnecessary costs like restaurant meals, cleaning services, unused gym memberships, cable bills, and banking fees. Get down to one vehicle rather than two (learn more about the best cars for seniors), or move somewhere with good public transit and go without a car. Use senior discounts whenever possible. It's essential to live below your means if you hope to retire early.
Boost your savings rate.
As you move up in your career and increase your income, adjust your savings rate upward as well. Any additional funds you receive through raises or bonuses should go directly toward your end goal of retiring early. It's wise to automate the process so that the money goes into savings before you ever have a chance to spend it. You won't miss it if you never see it.
Think about healthcare.
Unless you are entitled to disability benefits, you generally can't qualify for Medicare until you turn 65. So if you've been relying on health insurance through your employer and plan to exit the workforce early, you will need a way to cover your medical expenses. Under the provisions of the Consolidated Omnibus Budget Reconciliation Act (COBRA), you may be able to continue on your company's group health insurance plan after you retire. You will have to pay a premium, but costs will generally be lower than if you had to pay for coverage on your own. (Remember that if you're married and your spouse continues to work after you retire, you may be eligible for coverage through his or her employer.)
If you need to self-insure, a high-deductible health plan will have lower monthly premiums that can save you money if you're relatively healthy. And if you're on a high-deductible plan, you can open a Health Savings Account (HSA) to help pay your costs. An HSA allows for tax-deductible contributions, plus you don't pay tax on withdrawals so long as you use them for qualified medical expenses. A few examples of qualified expenses include:
- Prescription drugs
- Hospital services and doctor's fees
- X-rays and lab costs
- Dental treatments
How to Retire at 50
Want to get out of the game while you're still young? Review the information above, then check out these additional tips that show you how to retire happy at age 50:
Accelerate your savings rate.
Your funds may have to last you for 40 years or more, and retiring this early means you have a much shorter timeframe in which to save up. You also won't qualify for Social Security benefits for more than a decade after you retire. That means you may need to have 30 to 35 times your income saved if you want to depart the workforce at your half-century mark. Aim to devote at least 25 to 30 percent of your earnings each year to investing in your retirement goals.
Be wary of drawing from your retirement accounts.
The IRS imposes a 10-percent penalty on any 401(k) or IRA withdrawals you make before you are 59.5 years old. That means those tax-deferred savings that you worked so hard to build up are not available to you as a 50-year-old unless you wish to pay penalties for withdrawing funds early.
There are exceptions, however. Under the 72(t) rule, you can take distributions from your 401(k) or IRA at any age without paying any penalty, provided you take them in substantially equal periodic payments that continue for five years or until you are 59.5 years old, whichever happens later. But tread carefully. If you change your mind and decide to stop receiving the distributions before the end of the required period, you will have to pay the 10-percent penalty plus interest on all the money you received up to that point.
Create income from different sources.
Here's a secret for how to retire at 50 with no money: Have a long career in public service. In some cases, if you've put in enough years as a teacher, police officer, firefighter, EMS worker, civil servant, air traffic controller, or border protection officer, you can take early retirement at age 50 and begin collecting a pension. The IRS allows workers in certain public safety occupations who retire at age 50 or older to start taking distributions from government defined-benefit or defined-contribution pension plans (but not IRAs) without paying the 10-percent early withdrawal penalty. So if you qualify for a pension, you could conceivably retire early without having much in the way of savings.
If you're not eligible for a pension, you can help fund the gap between retiring at 50 and accessing your retirement accounts at 59.5 (or Social Security in your 60s) by looking into opportunities like owning rental property, setting up a taxable brokerage account, or purchasing an annuity.
You can also get a sizeable chunk of cash from selling your home and moving into a smaller condo or apartment. If you're married and have lived in your home at least two out of the last five years, the IRS will allow you to sell the home and exclude $500,000 in gains from income tax. (If you're single, you can exclude $250,000.)
Consider a Roth IRA conversion ladder.
You can convert funds from your other retirement accounts into your Roth IRA without paying the early withdrawal penalty. As long as you leave the converted funds in the Roth IRA for at least five years, you can withdraw the amount without paying any taxes or penalties, regardless of your age.
Say you have substantial savings in your 401(k) and need $30,000 of income a year starting at age 50. Beginning at age 45, you could convert $30,000 each year for 10 years from your 401(k) to your Roth IRA. (This is known as a conversion ladder.) That way, when you turn 50, you can withdraw the funds each year until you reach the magic age of 59.5 and can fully access the rest of your retirement accounts.
The big caveat here is that you do have to pay income tax on the converted assets when you move them into the Roth IRA. Also, you'll want to be sure that your withdrawal schedule doesn't deplete your retirement savings to the point that you have nothing left when you turn 60.
How to Retire at 60
If your retirement plan includes walking away from your job when you're 60, almost all of the steps outlined in the sections above apply to you, so be sure to read through that information.
The major differences are that working past the age of 50 gives you more time to save, plus you can contribute extra money to your 401(k) and IRA accounts. After you turn 50, you're allowed to put an additional $6,000 into your 401(k) for a yearly total of $24,500. You can also put an extra $1,000 (or a total of $6,500) into your IRAs. Then when you retire at 60, you'll have full penalty-free and tax-free access to your retirement savings.
If you don't have savings or access to a pension, you'll have to take a different approach. Learning how to retire at age 60 with no money is possible with some discipline and careful planning. Start by reducing your expenses and sticking to a strict budget. Since you're still two years away from being able to claim Social Security benefits (unless you are eligible for survivor or disability benefits), you may want to focus on raising funds through working part-time and/or selling off physical assets like your vehicles, antiques, or rare collectibles. Learn more about how to retire without savings.
How to Retire at 62
Many Americans retire at the age of 62. If you're aiming to be one of them, start by reviewing the information in each of the sections above, since most of it applies to you.
The main point about this age is that you can retire at 62 and collect Social Security, assuming you qualify based on your work record. Just be aware that if you do collect those benefits, the amount you get when you retire is less than if you wait until your full retirement age. Anyone born between 1938 and 1959 has a full retirement age ranging from 65 to 67; if you were born in or after 1960, your full retirement age is 67.
If your full retirement age is 67 and you start taking benefits at age 62, the amount you'll get each month will be 30 percent lower than if you wait until age 67 to collect. The trade-off is that you will receive benefits for a longer period of time. So, if you live an average lifespan, you could end up receiving the same amount in total benefits over your lifetime whether you start at 62 or 67.
Claiming Social Security at 62 can be a wise move. If you're planning to travel, 62 might be the right age to retire and claim benefits because it can allow you to get out and explore while you're still physically able to do so. If you're not in good health and don't expect to need the benefits for an extended period, it also makes sense to start collecting as early as you can. And if you don't have much other income, Social Security can provide a valuable source of funds. In fact, about 34 percent of retirees live on Social Security alone.3 (The average benefit is about $1,404 per month, or $16,850 per year.4)
How to Retire Without Savings
Are you trying to figure out how to retire on little money? There's no doubt that it can be a challenge. Be sure to take advantage of any senior discounts and assistance programs you're entitled to. If you strive to maximize your income and minimize your expenses, retirement can be within your grasp. Following the steps below can help you achieve your goal:
Get rid of debt.
You don't want to go into retirement with consumer or credit card debt weighing you down. Every dollar you spend on interest payments is one less dollar that can work for you in retirement. It's important to make every effort to clear such obligations before you leave the workforce for good. One strategy is to start by paying off whatever debt comes with the highest interest rate and proceed from there.
Consider a late career change.
If you're looking ahead and hoping to retire in the next 10 years, it might be worth your while to pursue a corporate or government position that comes with a pension. For instance, if you become a federal government employee and serve for at least five years, you can retire at age 62 and qualify for a defined-benefit pension plan (which includes a cost-of-living adjustment). The longer you serve, the more you will be entitled to receive.
Put off claiming Social Security benefits.
While it's not ideal, you can live on Social Security alone; about a third of retirees do. To increase your benefit amount, avoid applying for Social Security until you reach at least your full retirement age (which is somewhere between 65 and 67, depending on when you were born). That way, you will receive 100 percent of your benefits.
However, the longer you wait to start collecting, the higher your monthly benefit will be. In fact, because of delayed retirement credits, age 70 is the best time to retire if your goal is to maximize your benefits. If your full retirement age is 67 and you wait until age 70 to claim, you can boost your entitlement by 24 percent. (There is no advantage to delaying beyond age 70, however.) Remember: The benefit amount you first receive becomes the baseline for the amount you will get for the remainder of your lifetime.
Working on a part-time basis can go a long way toward sustaining a more comfortable retirement. And it's a very common phenomenon: More than two-thirds of retirees work at part-time jobs in the first couple of years after leaving the full-time workforce.5 Think about continuing in your current field as a consultant or advisor, or taking on a completely new role that allows you to leverage your skill set or try something different. (Just keep in mind that if you are also collecting Social Security benefits and have not reached your full retirement age, your benefits will be reduced if your employment income exceeds a certain amount.)
Get a tenant or roommate.
If you own your home, renting out space in it can be a good way to cut your costs and free up some cash for your retirement. This type of arrangement can work well if you have an unused bedroom that once belonged to a child or a separate area like a basement suite. Whether you approach a friend or advertise to the wider public, it's wise to create a written rental agreement that stipulates the amount of rent that will be paid each month, what's included in the price (i.e., utilities, parking, etc.), and what your ground rules are regarding pets, smoking, and other issues. Websites like Senior Homeshares and Silvernest can help older adults connect with potential housemates.
Look into a reverse mortgage.
If you have accumulated significant equity in your home and you are 62 or older, you might consider getting a reverse mortgage. This is a loan in which the equity in your home is used as collateral. To qualify, you must live in and maintain the home and be able to cover home insurance and property taxes. With a reverse mortgage, you receive either a line of credit or a series of cash payments that can be used any way you wish. You continue to own the home, and no payments are required on the loan until you die or move out. Talk to a financial advisor to see if this option would be appropriate for you.
Chart Your Retirement Path
As you can see, there are many routes to a happy and comfortable retirement. It all starts with setting a goal and learning how to manage your finances. So talk to a financial advisor and put your plans into motion today!
- 1 Gallup, "Update: Americans' Concerns About Retirement Persist," website last visited on August 7, 2018.
- 2 Employee Benefit Research Institute, Change in Household Spending After Retirement: Results from a Longitudinal Sample, website last visited on August 7, 2018.
- 3 Social Security Administration, "Fast Facts & Figures About Social Security, 2017," website last visited on August 7, 2018.
- 4 Social Security Administration, OASDI Beneficiaries by State and Zip Code, 2017, website last visited on August 7, 2018.
- 5 Merrill Lynch, Leisure in Retirement: Beyond the Bucket List , website last visited on August 7, 2018.