I hate to break it to you, but worrying about your finances doesn't stop once you leave the workforce. In fact, for a lot of people, financial worry ramps up as they find themselves facing decades of living on a fixed income. But you can reduce yours by planning your retirement carefully right now.
Here are three things you can do to improve your retirement readiness today, so you can have the best shot at enjoying some relaxing senior years.
1. Plan out how you'll spend your retirement
You need to know how you want to spend your time in order to know how much retirement will cost you. An active retirement involving a lot of travel and hobbies will cost more than a quiet retirement spent largely at home. You also have to think about any big-ticket purchases or donations you plan to make.
Make a list of all your estimated retirement expenses and then try to approximate how much each will cost you. Remember, some of your expenses may decrease between now and retirement while others could increase. Your housing costs may go down if you pay off your mortgage, but your travel costs could go up if you take many trips. So you can use your current spending as a baseline, but you'll have to adjust each figure up or down accordingly.
Once you know approximately how much you'll spend annually in retirement, you can estimate the total cost of your retirement by multiplying this figure by the number of years you expect your retirement to last, adding 3% annually for inflation. A retirement calculator can do this math for you, and it should tell you how much you must save monthly to reach your goal.
Once you're in retirement, stick to the budget you laid out as best as you can. If you have unexpected expenses come up, try to trim back some of your other expenditures to make up for it so you don't run short.
2. Save as much as you can while you're young
Your earliest retirement contributions usually end up being worth the most because they have the longest time to grow in value before you take the funds out. So starting early is one of the best ways to make saving for retirement easier.
If your goal is to save $1 million by the time you're 65, you'd only need to save about $305 per month if you started at 22 and earned a 7% average annual rate of return. But if you waited until 25 to start, you'd need to save $381 per month, all other factors being equal, and if you waited until 30 to begin saving, you'd need $555 per month. That's because the older you get, the less investment earnings you can count on, so you must make up the difference with additional personal contributions.
You should aim to save at least as much as your retirement plan recommends every month, but you can save more if you want to. Doing so could enable you to retire earlier than your original plan if you decide you want to.
If you find you cannot save as much as your plan recommends, try cutting expenses to give you more cash for retirement savings. Or go back to the drawing board and rethink your retirement. Remaining in the workforce a few years longer can help shore up a retirement shortfall quickly because it gives you more time to save while also reducing the length of your retirement.
3. Have a plan for withdrawals
Probably the best-known retirement withdrawal strategy is the 4% rule. This involves withdrawing 4% of your retirement portfolio in your first year of retirement and then adjusting this amount for inflation every year thereafter. It's popular mostly because of its simplicity, but it doesn't always work for everyone. It's still possible to run out of money using this approach, which is why some people prefer a 3% withdrawal rule instead.
Another popular formula the Center for Retirement Research at Boston College suggests involves dividing your total retirement account by your estimated life expectancy as reported in the IRS's life expectancy tables. So if you have $1 million and you're 65, you'd find your estimated life expectancy in the table, which is 21 more years, and divide $1 million by this amount. This gets you a little over $47,600. That's how much you could safely withdraw that year. But this approach gives you less money in early retirement.
If you're more active, you may spend more money in your younger years than you do later. In that case, you might be better off choosing one of these methods as your baseline and then adjusting it as you see fit. If you know you're going to travel and you budgeted for the cost of your trips in your retirement plan, you can adhere to your withdrawal strategy for your routine expenses and use the funds you set aside especially for your trip to cover these costs.
It all comes back to good planning. Yes, that takes some more time and effort on your part right now, but if you get these things out of the way, you won't have as many difficult financial decisions to make once you're retired. You'll already know how much you can safely spend, and you can just follow the strategies you already have in place.