How Do You Retire?

By Justin Pritchard, CFP®

Retirement may be an intimidating topic, but it’s relatively straightforward. Making it happen can be easier said than done, and may require good fortune, discipline, and other factors that work in your favor. 

If you’re wondering how to retire, you can see the process from start to finish below. Feel free to skip down to wherever you are in your journey (if you just need to plan your income, for example) or read the entire article. Alternatively, see more action-oriented instructions if you’re about to retire in the near future.

On this page:

  • Build Up Savings
  • Manage Your Assets
  • Know Your Need
  • Plan Your Income
  • Monitor Your Progress
  • Stay Healthy and Engaged

Build Up Savings

One of the first steps is to accumulate assets. This is ideally something you begin early in your working years—ideally in your twenties, although many people do not begin until later. The most important thing is to just get started whenever you can and to set money aside for retirement.

Whenever possible, it may help to take advantage of employer retirement plans and get potential tax benefits by using retirement accounts.

Employer Plans

If you work for an organization that offers a retirement plan, it’s smart to review the offering carefully. Your employer might contribute to the plan on your behalf, helping you build up the savings you need. But you might need to contribute to receive a matching contribution, so it’s critical to understand the plan’s rules and avoid leaving money on the table. Ask your HR department about any 401(k), 403(b), SIMPLE, or other plans available through work.

Pension plans: Some employers also offer a pension (or “defined benefit”) plan. Those plans are typically designed to replace a portion of your income when you retire. If you have a pension, you might not contribute to that plan—your employer does it all, in some cases—but you can still contribute to a 401(k) plan or similar plan to boost your savings.

We’re increasingly on our own for retirement savings, so it’s important to save money in any plans available to you. While that’s often a challenge, try to at least get the full employer match, if applicable. For example, if your employer matches 4% of your 401(k) contributions, you can essentially double your money when you contribute 4% of your pay.

Self-Employed Plans

How do you retire if you’re self-employed? You may be able to set up your own retirement plan, even if you’re also an employee at another organization. Several different options are available to self-employed individuals, including freelancers, consultants, side gig workers, and others.

Individual Accounts

Whether or not your employer offers a retirement plan, you may have several ways to save money on your own. 

Individual Retirement Accounts (IRAs) are available to almost everybody, and they’re excellent tools for adding to your savings.

The benefits you qualify for depend on your income, your job, and other factors, so it’s critical to check with a tax expert before you open an account. For example, you might or might not be able to deduct contributions to an IRA, or you might not qualify for a Roth IRA if your income is above certain limits. That said, almost anybody can contribute to a traditional IRA (but the contributions might not be deductible).

Health Savings Accounts (HSAs): If you have a high-deductible health insurance plan, you may have an additional savings tool available. HSAs have triple-tax benefits, but you need to be eligible to contribute:

  1. Your contributions might lower your taxes this year.
  2. Any earnings in the account may be shielded from taxes.
  3. When you take withdrawals for qualified medical expenses, you might not owe any income tax.

The rules can be complicated, but if you’re eligible to use an HSA, it’s worth considering. You don’t need to spend the money each year on your healthcare needs, either. Instead, you can leave money in the account until retirement—you’ll almost certainly have healthcare expenses as you age.

How Much Do You Need to Save?

The exact amount you need to save depends on things like your age, your spending goals, your investment returns, and more. But most people want more guidance than that. The chart below illustrates how you retire with some rough numbers (but you really need to run detailed calculations for meaningful information).

Example: Assume you earn $80,000 per year, you’re 40 years old, and you want a similar standard of living in retirement. This projection estimates that you should save roughly 22% of your income. If you start earlier, at age 30, you would need to save 13% of income.

Savings rate needed to retire at certain ages

Manage Your Assets

Your investment decisions will likely affect how you retire: When you can afford to retire, how much you pay yourself each month, your likelihood of success, and more. You might think of retirement investing as having two phases:

  1. The accumulation phase, where you build up savings
  2. The distribution phase, where you spend down your assets

Your Savings-Building Phase

When growing your savings, it may be smart to invest with a goal of growth. However, that only makes sense if you can tolerate the market’s ups and downs, and if you have time to improve your chances of getting long-term growth. Over long periods, markets have tended to rise, but taking risk requires that you ride out some bumpy and scary times. The longer you have, the better your chances.

The illustration below shows potential historical outcomes over different time periods. For one-year periods, you might have earned 47% or lost 39% in the U.S. stock market. That’s basically a coin toss—not much different than gambling. 

Rolling investment returns over selected periods, suggesting a long-term perspective for investors

But what if we look at every 10-year slice of history from 1950 to 2019? If we pick the worst 10-year outcome over that time, you lost 1%, and the “worst” doesn’t happen often (although it’s always possible to break records and see an even worse “worst”). Granted, the upside is not as dramatic, but there are always tradeoffs when we’re talking about risk and return.

Also, note how mixing your money among stocks and bonds can also reduce risk. Those returns are not as wide, and they tend to hover above the black (zero) line. Bonds are sometimes considered safer than stocks, but they can also lose money and they have unique risks.

What if you’re planning to retire in just 15 years or so? That’s long enough to take some risk, but the biggest impact might be the amount you save toward retirement.

Your Retirement Years

The conventional wisdom is to reduce risk as you age. That’s typically because you have less time to recover from market losses, and you have more to lose. Losing 40% doesn’t sting as much when you’re 20 years old and you only have $1,800 (yes, it still stings, but it’s even worse when you’re 65).

One of the biggest risks retirees face is the risk of sharp losses right at (or shortly after) retirement. Academics call this the “sequence of returns” risk, and they find that when you’re taking income early in retirement, a market crash can have severe consequences. Ultimately, your risk of running out of money increases if you have a bad sequence of events at retirement.

Because of this, it’s crucial to review your risk level and run “what-if” scenarios as you approach retirement. Ideally, you’re doing this several years before retirement so you don’t get caught off-guard.

Chart with sequence of returns in retirement investing

Should you completely eliminate risk at retirement and move everything to a bank account? Not necessarily. Prices will likely rise due to inflation during your retirement years, and if your assets don’t grow, you risk losing purchasing power over time. Put another way, $100 won’t buy as much in 15 years as it does now, so you may want to pursue at least some growth.

Know Your Need

To retire, you need to know how much income you need to live comfortably. There are several ways to do that, which are detailed in this article. To summarize, you can use:

  • Income replacement: Decide how much of your current income you’ll need in retirement. You might only need 85% of your current earnings, for example. That could make sense when your home is paid off, you’re no longer paying payroll taxes, and you don’t need to commute or dress up for work.
  • Lifestyle estimate: You can also pick a round number, such as $70,000 per year, but this is not a precise method. Plus, you might be tempted to estimate more than you need, which means you need to make sacrifices or work longer than necessary.
  • Detailed budget: The ideal approach is to create a detailed spending plan. You don’t need to go crazy, but the more detail, the better. This allows you to specify exactly when you pay off the mortgage, or when other expenses might change for you.

Once you know your spending goal, you can develop an income plan. This is similar to going on a road trip with your destination in mind: How do you retire comfortably unless you know how much you need to be comfortable? You need a destination.

What About Healthcare?

Healthcare is one of the biggest unknowns for retirees and pre-retirees. You don’t know what your body will do, and you don’t know what the U.S. healthcare system will look like in 15 years. For now, we just need to make decisions with the best information available.

We have excellent data on how much healthcare costs in retirement. For example, a 65-year old woman with a few health issues might spend about $7,000 per year out of pocket, and those costs would probably rise each year. If she has better health, the cost might be closer to $5,000 per year.

Be sure you’re at least doing something to account for healthcare expenses—even if it’s not perfect. Also, recognize that a long-term care event can result in off-the-chart healthcare expenses. It’s hard to plan for those events, but you can use insurance to mitigate the risk, if it makes sense.

Plan Your Income

Income might be the topic that gets the most attention in retirement planning. 

Your income usually falls into two categories:

  1. Guaranteed sources of income (Social Security, pensions, and annuities)
  2. Withdrawals from your savings and investments

You’ll start with a “base” of income that comes from guaranteed sources. Then, you can supplement that income by drawing from your retirement savings.

Social Security

For at least 50% of people over age 65, Social Security is a major component of income. It often provides half (or more) of a household’s income. The average Social Security retirement benefit is $1,514 per month, or roughly $18,000 per year. If you live with somebody, you can double that for an annual household income of $36,000.

You can start taking Social Security as early as age 62 in most cases. But if you claim “early,” you receive less. Waiting until your full retirement age results in a bigger monthly payment, and you can maximize your Social Security income by waiting until age 70 to claim. 

Remember that your choice may affect a survivor. If your spouse takes over your Social Security income after your death, it can be tragic to claim early and leave them with a permanently reduced benefit.

Don’t worry: You can still retire at age 62 or earlier—but you might not want to take Social Security right away.

Pensions

Some people are fortunate enough to receive a pension. If your employer offered a “defined benefit” plan, you might receive a monthly payment that lasts for the rest of your life (and it might continue to a beneficiary after your death).

Pensions are not as popular as they used to be. But if you work for government bodies, school districts, certain private companies, or other organizations, you might receive a pension. Especially if you work in government, your pension might offset or reduce your Social Security benefits, so it’s essential to find out how those sources of income interact before you retire.

Spending Your Retirement Savings

Add up your guaranteed sources of income to arrive at a base monthly income. If you need more than that each month, you’ll need to supplement the income by withdrawing from your retirement savings. So, how much can you withdraw without running out of money?

The 4% rule is a well-established rule of thumb that helps you estimate how your retirement might unfold. The “rule” (it’s not really a rule, and you can often break or bend it) is controversial, but it’s useful for quick estimates. Some people say 4% is too high, while others argue that you can withdraw more than 4%. Ultimately, you’ll need to decide what number is right for you.

The 4% rule says that you can withdraw 4% of your retirement savings balance, and the funds should last for 30 years or more. This “safe” withdrawal rate was designed to weather some of history’s worst markets without causing retirees to run out of money. Still, you can’t be certain that it works in every case.

Why only 4% (or less)? The number may sound low, but you will adjust your withdrawals each year for inflation. In other words, you give yourself a raise every year, and you don’t want to run out of money, so you need to start fairly low.

For example, assume you have $600,000 saved for retirement. Using the 4% rule:

  • 4% of $600,000 is $24,000 (multiply $600,000 by 0.04)
  • In Year 1, you withdraw $24,000
  • Assume that inflation in Year 1 is 2%
  • 2% of $24,000 is $480 (multiply $24,000 by 0.02)
  • Add your inflation adjustment to your annual income
  • In Year 2, you withdraw $24,480
  • Continue the process

Monitor Your Progress

Congratulations! You’ve done the heavy lifting (planning your retirement and completing all of those years of work). After you retire, it’s smart to monitor your progress and verify that things are going smoothly. You don’t need to obsess over your money, but checking in on your accounts a few times per year should be sufficient for most people. 

When markets crash, you’re in a particularly precarious position. You might be tempted to take drastic action, but that could backfire (or not, but it’s best to just set yourself up with an appropriate amount of risk before markets crash). When your investments lose value, every withdrawal takes a proportionally bigger bite out of your retirement savings. As a result, if you can reduce or pause your withdrawals during market weakness, you may improve your chances of success.

Stay Healthy and Engaged

Transitioning to retirement is a major life change. It can be stressful, and it might be weird to not have to work anymore. Make a plan for how you’ll spend your time, and try to include more than just your favorite recreational activity.

Think about it: You have 9,125 days during a 25-year retirement. Hopefully, you’ll live for 30 years or more, but you might be less active in your later years. Can you really spend that many days doing one or two things? Start a list of new hobbies, groups, and interests to keep yourself engaged both mentally and socially.

Your physical health is also important. Not only can good health reduce doctor visits, but it may also save you money. While some health conditions are beyond your control, you might be able to make small improvements by staying active. Things like walking, eating well, and getting flu shots (all with your doctor’s supervision and permission) can go a long way toward keeping you healthy.