You have your finances in order, maybe have a Drip or two, perhaps contribute to your 401(k). You may also have opened a discount brokerage account.

What is all this investing for, if not to be used and enjoyed at some point? Close your eyes and envision yourself sunbathing on the black-sand beaches of Wai'anapanapa on Maui, for instance. Or sipping cappuccino in Carrara, where Michelangelo went to choose the stone out of which he carved his David and his Pieta.

Sculpt thyself

Your retirement plans may now be a mass of shapeless stone weighing you down. What we propose to do here is to take out our modern-day hammers and chisels -- our calculators, community, strategies, and Roadmap to Retirement Online Seminar -- to mold something precise from that stone. You'll find these tools in our Retirement Area. But before you pound the chisel for the first time (and hack off the femur by accident), you may be itching for a little guidance.

The six steps

To ensure a successful retirement -- whether you want to quit the workforce at 35 or 70 -- you must:

  • Think about what kind of lifestyle you want in retirement, and how much you're going to need per year to support it
  • Figure out how much you'll need on the day of retirement in order to make sure you can draw the amount you need (see the "multiply by 25" rule below)
  • Take an educated guess at how long you'll be retired
  • Decide where you will live, and whether to rent or buy
  • Ensure you have adequate health and medical insurance for the family
  • Decide how to fill the hours in a day previously devoted to work

The "multiply by 25" rule

There's a handy (though not entirely accurate) little formula, developed by mathematicians who are still stuck in a maze somewhere in Palo Alto, to help you figure out how much money you need to set aside now to meet a certain annual expense for a long time -- for eternity, in fact. First you figure out what your real rate of return (that is, adjusted for inflation) on your savings. For example, assume your long-term overall annual rate of return on all investments will be 8%, and that at the same time inflation will run 4%. That gives you a real rate of return of 4% (8% minus 4%). You divide that 4% into 1.00, giving you 25. Multiply your annual expense in retirement by that number to arrive at the "lifetime expense" -- that's a very rough estimate of how much you'll need to have on your retirement date to cover those costs in the future.

Another way of expressing it is to say that you need to put aside $25 to fund each $1 of annual spending in your budget. If your total annual spending in retirement will be $50,000, the "multiply by 25" rule indicates that you need to save $1.25 million before giving up the paycheck.

Though not perfect, this equation allows you to consider various scenarios. What if it were possible to cut your retirement spending to levels well below your current spending? If reducing your expenses allows you to get by on less income, you'll lower your tax burden as well. So taking the above assumption, if you were able to bring your annual spending in retirement down to $30,000, the "multiply by 25" rule indicates that you would need to put aside $750,000 before retirement, a considerably smaller sum. Of course, if you invest well, then you actually have to "put aside" much less and let investment returns make up the difference.

Keep in mind that this calculation does NOT incorporate Social Security, pension benefits, money you may earn from work after retirement, marrying into a fabulously wealthy family, and so on. It assumes no other sources of income than your investments. This will (we hope) not be the case, but it's better to err on the conservative side -- to assume that we'll have less. Then, of course, if we have more than we planned on, we can live the high life (whatever that is).

How long will you be retired?

This has two parts: When you will retire, and how long you will live.

You choose when you retire; there is no right answer. Select a date, or choose the age at which you want to retire. Whether it's 35 or 55 or 69 -- it's your choice.

Then, to get a genetically informed guesstimate as to how long you may live, take a look at your parents and grandparents. Who lived the longest among them? Take that age, add 10 years to it (you're eating your leafy greens, right?), and use that number.

Subtract from that the age you'll be when you retire, and voila! You have a working number for how long you'll be retired.

Where you stand

In order to arrive at a target amount on your date of retirement, you must determine your current financial status. If you use a software program such as Quicken or Microsoft Money, you'll find your work simplified. Essentially you need to tally up how much money is coming in right now, and also what you have in terms of assets. You're invested in the stock market, right? Since you know the date your retirement is to begin, our online calculators should help you project how much your portfolio will be worth at that time. You can then compare that with the amount you know you'll need on the Big Day, and see whether you need to invest more.

We should mention, of course, the magic of compound interest. The longer you have for your investments to grow, the larger the growth will be. That's why there's no time like the present to begin!


Among the important weapons that are potentially in your arsenal, you should check into the following:

  • Employer-provided pensions, otherwise known as defined benefit plans. These plans are dying off as employers switch to 401(k) plans or hybrid vehicles such as cash balance plans.

  • 401(k)s or 403(b)s. Your employer may match the contributions that you make to this plan, up to a certain amount -- and that means that you're getting free money. "Free money." Hmm... we like the sound of that. Couple the free money with tax-deferred compounding, and you've got a great tool for amassing a sizable stash by the time you retire.

  • IRAs. If you're eligible, there's really no good reason why you shouldn't have one -- whether you choose a Roth IRA or a traditional IRA. Each of these provide great tax advantages, and the flexibility to be invested in the stock market all the while. The Roth IRA is appealing because, if you follow the rules, you can withdraw money you've contributed to it, as well as any earnings on the money, completely tax-free. You can contribute up to $3,000 per year to a regular or a Roth IRA.

Periodically, you must evaluate your progress toward meeting your retirement needs (we recommend at least once a year), and then make revisions where required. After all, things change -- rates of return, unexpected expenses, and so forth. So be sure to stay on top of that changing scene by reviewing your retirement savings goals and investments annually. And as we point out in Step 2 of our 13 Steps to Investing Foolishly, it doesn't hurt to get a second set of eyes reviewing your plan. If you're a TMF Money Advisor subscriber, make a date with your planner to see if you're on track. Go ahead, we'll wait.

The early bird and the can of worms

Great, you're back. Achieving a successful early retirement is another matter. Planning for an early retirement is much more difficult than it is for a "normal" retirement. That's because some unusual hurdles will crop up. For example, health and medical insurance present a special problem. Medicare isn't available until age 65, many employers will not allow group plans to be carried into retirement beyond the 18 months required by law, and individual health policies may cost in the hundreds of dollars per month. For the early retiree, then, obtaining adequate health and medical coverage can put a huge dent in the family's income.

Insurance is often the greatest deterrent to retirement prior to age 65. For more information, visit our Insurance Center.