Retirement 101: What is retirement, anyway?

OK, now that you’ve got the ball rolling (You did, right? You started contributing more to your retirement savings, even if it’s only $10 per month more? No? Do it! Do it now!) It’s time to make a more specific plan. We need to figure out how much money we’re going to need for retirement, and then we’re going to need to figure out what it will take to get there. But first, we’re going to define a few terms so that you’ll be ready for them when they come up. 

• Retirement number: The amount of money you need to save in order to be able to expect to make it safely through a 30-year retirement.
• Safe withdrawal rate: The amount of money you can withdraw each year during retirement that allows you to safely expect to never run out during your lifetime. This goes hand-in-hand with the retirement number. Most professionals recommend a safe withdrawal rate based on the Trinity Study, wherein researchers ran various 30-year retirement scenarios through the available history of the US stock and bond returns. They found that a withdrawal rate of 4% in the first year of retirement, followed by subsequent yearly withdrawals adjusted for inflation, was a reasonably safe way to ensure that you don’t run out of funds for at least 30 years after you retire. Other methods exist, but most tend to hover right around that 4% withdrawal rate. Personally, I tend to use 3.5% to add an extra safety buffer.
• Inflation: In a growing economy, the amount of goods you can by with a dollar tends to go down over time. This is why we say things like “a $10,000 salary in 1950 is worth $110,000 in today’s dollars.” We won’t get into the mechanics of why this happens right now, but the key takeaway is that we need to account for inflation when thinking about future expenses. We generally do that by using…
• Inflation-adjusted returns: By accounting for inflation in our expected investment returns, we make it so that our future gains are expressed in today’s dollars, not expected future inflated dollars. This allows you to more easily estimate your retirement expenses without having to increase each expense for inflation. This also means that your retirement number is expressed in “today’s dollars,” because it’s based on your current expenses. When you retire, your retirement account will actually be larger than your original retirement number, but it will be worth the same, in terms of spending power. This may sound a bit confusing, but in practice it’s not a problem. The closer you are to retirement when you calculate your retirement number, the less of a difference there will be. I recommend that you double-check your expenses and recalculate your retirement number once every year or two. As you approach retirement, your retirement number and the actual balance you need in your accounts will converge automatically.

Those are all critical terms to know in order to continue, but we’re missing the most important one: Retirement. What exactly does retirement mean? The simplest, broadest definition is that retirement is the state of no longer working for income. A lot of people stop there, but I believe that’s not enough. It’s not a description of what retirement is so much as what it isn’t. So you are working anymore. Now what? What will you be doing? Too many people look forward to the day that don’t have to go to work anymore, but don’t have any plans for what they will do, instead.

In order to plan for retirement, you need to have a clear vision of what retirement will be, for you. 

So, the next step in figuring out how much you’ll need to retire is dreaming. No, really. Sit back, close your eyes, and imagine what it will be like to be retired. Where will you live? What hobbies will you have? How often will you go out to eat? Be realistic, but don’t sell yourself short. And try to avoid the stereotypes. If you’re not into golf at age 40, there’s no reason to imagine that you will be at 65. If you’re happy with the place you live, there’s no need to imagine moving to Florida.