One of the biggest worries folks have as they approach retirement is whether or not that they have enough money to retire. Since the goal of this blog is to “Help People Achieve A Great Retirement”, it seems appropriate to address that worry with this step-by-step plan.
Follow these 10 steps and worry no more. They’re the steps my wife and I followed when we were making the decision on when to retire, and I’m confident they’ll serve you well as you make your decision.
A word of warning: This is a meaty post, but I’m convinced that this post will do more to prepare you financially for retirement than any single post I’ve written in the past 6 years. I’ve invested significant time in writing it, and I strongly believe it will be invaluable as you prepare for retirement.
This post will do more to prepare you financially for retirement than any post I've written in the past 6 years. I trust you'll find it of value. Click To Tweet
Disclaimer: I am not a financial professional, and none of this advice should be implemented without a detailed review of your specific situation. These are the steps that worked for my wife and I, so please take them only as suggestions of a course of action which you can serve as an example for your consideration. Your situation IS different than mine, and the steps I followed may not be appropriate for your situation.
I was honored whenTom Dickson invited me to appear as a guest on his Financial Experts Network. As we talked about potential topics, I suggested something along the lines of how to ensure you have enough money to retire. He liked the idea, and I built a presentation. I’ll be presenting it to ~800 financial professionals next week (it’s even been certified, and they’ll receive educational credits for attending!). As I built it, I realized it was also a worthwhile topic for an article, and this post was born. For the record, I spent more time writing this post than I did on the presentation. You’re worth it. Wink.
With that, here are the 10 Steps to Make Sure You Have Enough Money to Retire:
1. Put on Your Game Face
First, recognize that retirement is, perhaps, the biggest financial decision you’ll make in your lifetime. Take it seriously, and commit to doing the work required to make a sound decision. To do it right, you’ll need to do some work. Don’t wing it, and don’t be afraid to hire a professional if you’re uncomfortable doing the following steps by yourself. Moving from years of accumulating your portfolio to withdrawing from those savings in retirement is a major shift. Don’t take it lightly. Game face on? Ok, let’s move to Step #2.
2. Design Your Dream Retirement
It’s important to remember that you’re trying to determine if you have enough money to retire. Before you can answer that question, you need to get a realistic estimate of what your retirement will cost. That cost will be driven in large part by the type of retirement you’d like to design for yourself. Before you start cranking on the numbers, take some time to think about what you want your retirement to look like. How much do you want to travel? Where do you want to live? Are you going to downsize? Are you going to do more entertainment with that increased free time? Dream for a few weeks, and talk with your partner. Decide what your priorities are going to be, and keep them in mind as you work through the next few steps.
As I cited in my book, Keys to a Successful Retirement, there is a proven correlation between the amount of time one spends thinking about retirement and the success of their transition into that retirement. Consider this step an investment in your future. Dream about retirement. It’s coming, and you’ll be well served by the time you invest thinking about it before it becomes a reality.
3. Track Your Current Spending
Remember Step #1? This is where that game face comes into play. Sure, no one enjoys tracking their spending, but it’s an essential step in determining if you have enough money to retire. Many folks don’t really know how much they spend in a year, but it’s impossible to determine when you can retire without a realistic estimate of your spending.
In our case, we tracked our actual spending for a year. I strongly encourage this approach. Sure, it’s painful, but the benefits are worth the cost. Download my free Spending Tracker, or build one yourself. (Note: If you choose to download my spreadsheet, just hit File/Make A Copy to save a version you can use for your numbers).
Once you’ve established a realistic baseline for your current spending, you’ll be in a much better position to estimate how that will change once you retire.
4. Forecast Your Retirement Spending
I’ve said before that “retirement is a math problem”. To complete the formula, you need to eliminate as many of the “x’s” as possible in the equation. One of the biggest unknowns is your retirement spending, but that doesn’t mean you should ignore it. Quite the opposite, since the answer to whether or not you have enough money to retire is driven, in large part, by what you expect to spend in retirement.
Starting with the details you’ve collected in Step #3, go through each spending category and estimate how it will change based on the retirement you’ve designed in Step #2. Here’s an example:
A few things to think about as you work through this one:
- Don’t forget health insurance. It’s a critical cost item, and could be a major expense (especially if you retire before you’re eligible for Medicare). We estimated $2,500/month for our private health insurance, and our actual cost has come in at $1,900/month in retirement.
- Plan conservatively (on the high side of spending). It’s better to have surprises to the good than the bad, as our health insurance example above illustrates.
- Don’t forget taxes, especially if you’re planning on doing Roth Conversions prior to getting hit with Required Minimium Distributions. We’re doing annual conversions up to the top of our marginal tax bracket, and it’s worked well for us. Fortunately, we built the annual tax burden into our retirement spending forecast.
Finally, it’s valuable to build a model that shows your spending over the duration of your retirement. You can use my free Retirement Cash Flow model as a template, or build your own. (Note: If you choose to download my spreadsheet, just hit File/Make A Copy to save a version you can use for your numbers).
Your spending will change over time (e.g., less travel as you age, but more health care expenses), and it’s helpful to look at your retirement spending over time to ensure you have enough money to retire, and stay retired.
For the sake of this example, let’s assume you’ve completed the work and have arrived at an estimated “Year 1 spend” of $60k in retirement. We’ll use this example in future steps.
- For more details, read When Can I Retire (Step 1 – Spending).
5. Calculate Your Net Worth
Understanding your net worth is a critical foundation for your retirement planning. When determining if you have enough money to retire, you must understand how much money you have to fund your retirement. In short, the Net Worth statement details all that you own (your Assets), and all of the debt you owe (your Liabilities). Subtract the liabilities from the assets, and you’ll calculate your net worth. In Step #6, we’ll calculate how you can use your net worth to fund your retirement.
An example of a Net Worth statement is below, copied from my free Net Worth Statement. (Note: If you choose to download my spreadsheet, just hit File/Make A Copy to save a version you can use for your numbers).
In the above hypothetical example, you’ll see a net worth of $519,500 on 12/31/20, with an increase to $756,500 by 12/31/23 based on projections for the next three years (this will be used as our example in the next steps)
It’s also helpful to know what the tax status is of the various holdings in your portfolio. Our example shows $257k in 401(k) Pre-Tax accounts as of 12/31/20. It’s important to note that you’ll have to pay the taxes out of that $257k before you can spend what’s left. The Net Worth statement will show you that and must be completed to determine if you have enough money to retire.
- For more information, read How Much Fuel Is In Your Tank?
6. Determine Your Safe Withdrawal Rate
Now that you know your Net Worth from Step #5, how much of those assets can you safely spend each year? The Safe Withdrawal Rate is a critical element in your retirement planning and helps guide you in determining how much you can safely spend. There is a ton of material available on various historical studies (the Trinity Study is the most well known), but I’ll summarize my opinion as this:
“A retiree should plan on withdrawing between 3 -4% of their retirement assets per year”
Where you fall in that range depends on a lot of variables (risk tolerance, age, asset allocation to name a few), but as a general rule of thumb (ugh) you should think of 4% as a more aggressive plan, whereas 3% would be a more conservative approach. To keep it simple, I like to look at both ends of the range, and consider them as “guardrails” for my annual spending range. It’s worth noting that SWR theory argues that you can increase your withdrawals by the amount of inflation per year.
Once you’ve completed your Net Worth, it’s simple to add a few lines to calculate your initial Safe Withdrawal Rate. In our case, we subtract assets we’re not willing to spend in retirement (e.g., cars, equity in our home, though you could include some home equity if you’re planning to downsize). I simply subtract “Non-Spendable Assets” to calculate “Spendable Retirement Assets”, which I then multiply by 3%, 3.5%, and 4% to calculate the annual spending our Net Worth can support, as shown below:
In this hypothetical example, the retiree could safely spend between $10,635 and $14,180 (with a midpoint of $12,408) based on their net worth as of 12/31/20. Projecting forward, the midpoint increases to $19,268 by 12/31/23. We’ll use these midpoint figures as examples in the following step.
- For more information, read Early Retirement Now’s Safe Withdrawal Rate Series, (the most comprehensive series on the topic that I’m aware of) or my article on How Much Can You Safely Spend In Retirement?
7. Estimate Your Retirement Income
Now that you have a realistic estimate for how much income you can count on from your investments, it’s time to add the other income sources into your planning to see how your retirement income compares to your expenses. This is the ultimate test for whether or not you have enough money to retire, so make sure you get your numbers as accurate as possible.
It is reported that 50% of workers don’t have a good estimate of their future Social Security benefits. Don’t be one of them. Simply log in to SSA.gov and use your actual numbers. SS is a critical component of your retirement income and one that you don’t have to guess. You have to decide at what age you’ll claim your benefits, but the SSA site will provide the information at various claiming ages. Add the appropriate SS figure into your retirement income benefit. If you’re retiring before you’re eligible, include it in the multi-year cash flow forecast for the year you plan to start your benefits.
After you’ve completed your Social Security estimates, continue the process for all other estimated sources of retirement income. If you’re planning on working part-time in retirement, make a conservative estimate to minimize the risk of a nasty surprise. Include a pension if you’re fortunate enough to have one, as well as any annuities or other income streams you expect. Include a line for the Safe Withdrawal Rate calculated in Step #6.
When completed, you’ll have the following summary, which compares your projected retirement income with the expenses you determined in Step #4 (note, I’ve used the midpoint SWR in the example below):
Based on this example, the hypothetical couple will need to wait to retire until they claim their Social Security in 2023 to ensure their projected income covers their projected expenses. If they would prefer to retire earlier, they could either reduce their expenses, increase their part-time work income, or increase their withdrawal rate from investments (Note their income exceeds expenses in 2023, so there is some merit in considering exceeding the “safe” maximum of 4% for a year or two, assuming they reduce it post-Social Security).
7a. Run A Retirement Calculator
Now that you’ve estimated the required inputs, I’d encourage you to run a few retirement calculators to compare their results with what you’ve determined to be a realistic retirement date. My favorites are New Retirement and Personal Capital (affiliate links, but I use both of these myself).
In my opinion, New Retirement is the best retirement calculator (I wrote a detailed review here), and Personal Capital offers some great dashboards that not only estimate your retirement readiness but also help manage your asset allocation (I use it every year as part of my Annual Review – see Step #10).
- For more information, read When Can I Retire (Step 2 – Income) and (Step 4 – Putting It All Together)
8. Develop Your Retirement Drawdown Strategy
Moving from the “Accumulation Phase” to the “Withdrawal Phase” of life is a MAJOR adjustment. For years, you’ve been adding to your portfolio (the Accumulation Phase). When you retire, you’ll begin to make withdrawals. Recognize the significance of that change, and prepare for it.
Before you actually retire, decide how you’re going to manage those withdrawals. Develop a detailed plan, just like I did. One year before I retired, I published Our Retirement Drawdown Strategy, and I’d encourage you to study that post as an example of the drawdown strategy you should create for your situation. That post is particularly valuable, as 21 other bloggers joined a “Blog Chain” at the end of the post with links to their own drawdown strategies (note a few of those bloggers no longer exist, so I deleted their links).
This post is getting lengthy, so I’ll summarize the types of issues you should include in your drawdown strategy. Please read my drawdown strategy for more details:
- How to mitigate the Sequence Of Return Risk (a bear market shortly after you retire).
- What your Asset Allocation should be as you enter retirement.
- Whether annuities make sense for your retirement plan.
- How you’ll access your pre-tax investments.
- If, and when, you’ll make Roth conversions.
- Tax optimization.
- How you’ll establish your retirement paycheck. (e.g., The Bucket Strategy, see Step #9).
- How you’ll handle unexpected expenses.
- When you’ll claim Social Security (and your pension, if applicable).
- How you’ll handle health insurance.
- What you’re going to do about Long Term Care Insurance.
I encourage you to create a multi-year cash flow projection, showing how you’ll be withdrawing from your investments to fund your retirement, and what impact that will have on your portfolio over time. As I stated earlier, you can use my free Retirement Cash Flow model as a template, or build your own. (Note: If you choose to download my spreadsheet, just hit File/Make A Copy to save a version you can use for your numbers).
Getting mentally prepared for the transition to the Withdrawal Phase is one of the most important steps in determining if you have enough money to retire. A detailed Drawdown Strategy will help you visualize this transition, and go a long way in alleviating your worries about running out of money in retirement.
- For more information, read Our Retirement Drawdown Strategy.
9. Develop Your Retirement Paycheck
One of the most popular posts I’ve ever published is “How To Build A Retirement Paycheck From Your Investments”. In it, I laid out all of the details of how we were positioning our portfolio to provide a “paycheck” in retirement. In short, we’re using the Bucket Strategy, where 3 virtual buckets are used to designate which investments you’ll be using in various time frames to fund your retirement (e.g., Bucket 1 is 3-5 years of cash, designed to protect against Sequence of Return Risk).
I’ve since expanded on that original post with two additional posts which have shown how I’m “managing the buckets” in retirement. In my book, I dedicated a chapter to the issue, titled “What to do When The Paycheck Stops”). Yes, this is important stuff. Don’t retire without setting up your “paycheck” strategy.
Due to the length of this post, I’ll avoid rehashing the entire strategy here. If you’re interested in reading the details, links to The Bucket Strategy Series are below:
The Bucket Strategy Series:
- How To Build A Retirement Paycheck (How I set up the bucket system prior to retirement)
- How To Manage The Bucket Strategy(How I maintain the bucket system in retirement)
- Your Bucket Strategy Questions, Answered! (Q&A regarding the management of the buckets in retirement)
While the bucket strategy is far from the only strategy to set up your “retirement paycheck”, it’s critical that you think through various issues regardless of what strategy you decide to implement, including:
- How to ensure you stay within your Safe Withdrawal Rate limits.
- How you’ll avoid Sequence of Return Risk, especially in the early years of retirement.
- When you’ll rebalance your portfolio to maintain your targeted Asset Allocation.
- How you’ll manage “lumpy” spending.
- How you’ll offset the impact of inflation over time.
- How you’ll respond if the market declines, or improves.
10. Implement An Annual Financial Review
Finally, it’s important to remember that your retirement will (hopefully) continue for years. As you move through your retirement years, you must implement an annual review to ensure you’re staying on track. I do one every year, and it takes me less than 2 hours. I’ve outlined all of the steps I take in A Step-By-Step Guide For Your Annual Financial Update, including a free checklist which you can save by clicking that link.In summary, my annual review consists of the following steps:
The Annual Financial Update Checklist:
- Update Your Net Worth
- Capture Your Current Asset Allocation
- Determine Portfolio Rebalancing Actions
- Update Your Bucket Status
- Update Your Spending for the Previous Year
- Establish Your Spending Limits for the New Year
Having an annual routine helps ensure you maintain your safe withdrawal rate and don’t spend more than you’re able to afford. You should also consider expanding your annual checklist to update important estate documents, double-check your beneficiaries on all financial accounts, etc. You can customize your annual review to cover the items of importance to you, but you can’t safely retire without having a system in place to ensure you’re staying on track.
At 3,200 words, this is one of the longest posts I’ve written in 6 years of blogging. Hopefully, you’ve found it to be one of the most valuable. And to think, I could have easily summarized it with one picture:
Your Turn: For those of you who have successfully retired, what did I miss? For those of you who are thinking of retirement, are you ready to put your game face on? What questions do you have that weren’t covered in the article? Let’s chat…
