How to Save for Retirement in an Uncertain World

How much money do you need to retire? How long does the money need to last? How should the money be invested to give you a high likelihood that it lasts? 

Planning financially is a very difficult task because the world is full of unknowns. You have no idea how long you will live. You have no idea what market returns will be when you retire. You also have no idea how your expenses will change. 

Each person is unique, but if you look at entire populations, there are helpful averages. I know nobody wants to be average. Each person wants to be unique, but it’s a good starting point for any planning. Once you know the average, you can adjust based on your individual circumstances – either scientifically or based on feelings.  

I imagine many of you are not thinking about retirement because it feels like it is a long ways away, but early planning helps. It can mean the difference between working another five years or relaxing on a beach when you want. 

Let’s talk about retirement. You may not be in a position to save towards retirement today or maybe you have been waiting to take the first step. Let this discussion be the motivation to start thinking about it and creating a more intentional plan. 

We’ll explore how to structure savings and investments until retirement, how to estimate how much you need to retire, and how to look at life expectancy.  

Which Accounts Should You Use to Save? 

Unless you earn an absurdly high income, inherited a massive sum of money, or married rich, you are likely going to need to invest some money in stocks. 

While you can invest in real estate, build income streams, and find other ways to create income in retirement, I’m going to focus on stocks because they have delivered fairly consistent returns over 30+ year horizons, between 7% and 10% depending on the time period. 

I’ve previously written about investing basics. I recommend reading it if you want more knowledge. 

To reach retirement, you are likely going to need to regularly invest money into the stock market. You will likely want to do it through a combination of retirement accounts, such as a 401(k), Roth IRA, or Traditional IRA, as well as a brokerage account. 

A brokerage account is another type of investment account without the tax-deferral or tax-free properties of a retirement account. Whereas a Roth IRA provides tax-free growth and a Traditional IRA provides tax-deferred growth, a brokerage account is taxed along the way and future sales are taxed at capital gains rates, which can be 0%, 15%, or 20%. 

A brokerage account is particularly helpful for people hoping to retire before age 59 ½ because most retirement accounts have a 10% penalty if you take withdrawals prior to age 59 ½. There are a few exceptions and ways around the penalty, but the key lesson is a brokerage account can be a good bridge to spend from until you are age 59 ½.

With a brokerage account, you pay tax on the dividends and interest along the way, which assuming you are not focused on dividend stocks, may be under 2% per year. For example, if you have a $10,000 brokerage account with stocks and bonds producing a 2% yield annually, you would have about $200 of dividends and interest. Some of this will likely be taxed as ordinary income and some will be taxed at your capital gains rate. The growth can continue without taxes until you sell. For example, if you put $10,000 into the brokerage account and sold everything in it 10 years later for $20,000, you would pay capital gains of $10,000. 

While most people focus on maximizing contributions to their retirement plans, a brokerage account should be considered once you at least earn enough to receive a full match if your employer provides one. It’s also reasonable not to consider a brokerage account until you fully maximize the amount you are allowed to contribute to your retirement plan, but each person’s situation is unique. 

If you solely focus on maximizing contributions to your retirement plan and never save money into a brokerage account, you may limit your options later. For example, if you maximize contributions to your retirement plan for 20 years and decide you want to start a business, you likely will have limited funds to do it, whereas, with a brokerage account, you could liquidate the funds to start a business. Also, if you wanted to take a sabbatical year, you won’t have easy access to your 401(k) without a penalty, whereas with a brokerage, account you could sell a portion to fund your sabbatical. 

The tax advantages of a retirement plan are helpful, but they are not everything. Life is winding and full of speed bumps. Sometimes it is better to have an account where you pay a little more in taxes, but provides flexibility as your life changes. 

Now that you know the differences between the different types of accounts, let’s talk about how often you should save.

I’m a big believer in regular, automatic contributions. Most people have trouble starting something, myself included, which means the first step is always the hardest. To set yourself up for success, I recommend automating your finances. 

What this means is that you should determine how much you can save regularly and transfer those funds each pay period into your retirement or brokerage account, and automatically invest. 

Personally, my 401(k) contributions are contributed each month, which is how often I am paid. I also have an additional transfer to a brokerage account and a calendar reminder to invest the brokerage funds each month. 

It takes no thought from me. The transfers happen automatically and the only manual process is buying an investment in the brokerage account each month, but because I already have an investment plan, I know what I am buying each month. I spend less than five minutes each month on this process. 

If you try to save money at the end of the month, manually make transfers, or allow the market to dictate when you invest, you likely will feel paralyzed more often than not and nothing will get done. It’s a terrible place to be. I see it happen to too many people. 

While it’s not glamorous to say save regularly and invest regularly regardless of what is happening, it’s as close to a sure thing to get closer to financial independence than most approaches. 

If you remember only a couple things from this part, remember this:

  • You’ll likely need to invest in stocks for their long-term growth potential. Historically, it’s been 7%-10%. 
  • Retirement plans are helpful vehicles to reach financial independence. 
  • Don’t forget about the power of a brokerage account for its flexibility. You live in an uncertain world and likely want funds available for when life does not go as planned. 
  • Automate, automate, automate.

How Much Do You Need to Retire? 

I’ve previously written about how much you need to be financially independent.

You likely need between 25 and 33 times your annual spending, depending on how conservative you are as a person. For example, if you want to spend $50,000 per year, you would need between $1,250,000 and $1,650,000 to retire. 

If you are very conservative and don’t like the idea of possibly going back to work if returns are lower or expenses are higher than anticipated, you may want to aim for 33 times your annual spending. If you are more of a risk-taker and confidently understand the 4% rule, 25 times your annual spending may suffice. Even something under 25 times your annual spending may work depending on the market returns early in your retirement. Plus, if you are retiring prior to collecting Social Security, you may not need $50,000 per year your entire life if your Social Security benefit will reduce the amount you need from your investments later. The 25 to 33 times your annual spending is a general rule of thumb. It’s always better to create a more in-depth financial plan.  

Personally, I’m aiming for 30 times my annual spending. I also recognize I am a conservative person when it comes to planning.  

Why am I aiming for 30 times my annual spending? 

  • I hope to retire and have a longer than 30 year retirement period. The 4% rule was built off a 30-year time horizon. 
  • Bond returns are likely to be lower than the time period studied. While all of my retirement assets are in stocks, as I get closer to retirement, I may have a more conservative portfolio with bonds. 
  • I see healthcare as a huge wildcard. Healthcare is widely expensive for many families. Up until the last decade, even getting healthcare was a challenge if you retired early. While tax credits exist today if you can keep your income low, if those went away, healthcare would likely be even more expensive. I simply don’t feel confident in saying what my healthcare expenses will look like in retirement. They could be a couple of hundred dollars a month to a couple of thousand dollars a month. With that much variability, I want more of a cushion with the amount I have for retirement. 
  • Taxes. I do not know what will happen with taxes. I think it’s likely I’ll see higher taxes at some point in my life. 
  • As Mike Tyson said, “Everybody has a plan until they get punched in the face.” Life happens. Things go wrong. Parents get sick. Friends need help. Opportunities pop up. I’d much rather work longer and end up with more money (at least at this point in my life) than retire with too little and drastically need to change my life to bridge the shortfall. 

Somewhere where I see many people go wrong is assuming what they spend today, they will spend in the future. If you just graduated college and can get by on $25,000 a year, kudos to you. Assuming you are going off 30 times your annual spending as your retirement figure, does that mean you only need $750,000 saved for retirement? Highly unlikely. 

Very few people keep their spending consistent over time. Most people spend more as they grow up, buy a house, travel, have kids, and outsource things they do not enjoy doing. Pro tip: save 50% of every raise. It’s a good way to give yourself a spending raise while looking out for your future self! 

Although it’s tough to say how much you need to retire, the first step is understanding how much you spend today and make the best educated guess you can about what it might be in the future. It will be wrong. I’m confident of it. But, it’s all you can do. 

When you determine what you might spend in the future, you can also look at how the average American household spends, as well as the lowest income quintile and highest income quintile. You can also see how spending has changed over time.

If you want to spend below average, remember it will require intentionality and doing things most people won’t. And, remember, there is nothing wrong with spending above average. Too often in the personal finance community, people focus solely on cutting expenses. There is nothing wrong with enjoying life and what money can buy. 

What is My Life Expectancy? 

The 25 to 33 times your annual spending is a helpful rule, but it says little about life expectancy. Yes, the 4% rule was built on a 30 year time horizon and says you will have a high likelihood of not outspending your money if you had a 50% stock and 50% bond allocation, but it does not say anything about life expectancy or retiring early. 

How long do you expect to live, and how long should the money last?

It depends. It depends on your gender, ethnicity, lifestyle habits, genetics, education, socio-economic status, marital status, and other factors. 

If you want a simple calculator, you can use Social Security’s calculator.

This is also an interesting calculator that takes into account more factors. Please keep in mind this is from a company trying to sell annuities, but it is helpful as a starting point. 

For most people, planning to live until age 90 is reasonable. If you want to be conservative, aiming for 95 is not unreasonable. A few years ago, there was about a 50% probability that a married 65-year old couple would live until age 90. They also had about a 20% chance of one of them living until age 95.

Most people consider it a low probability they will live until their 90s, but for married couples, it can’t be looked at individually. It must be looked at together. The data says there is a good chance one of them makes it until their 90s. 

What does this mean? 

It means if you retire at age 50, you want to plan on at least a 40 year horizon. If you retire at age 65, you want to plan on at least a 25 year horizon, though 30 years is more conservative. 

What am I doing personally? 

I’m aiming for age 90. I’m conservative in other areas of my plan, which means I feel comfortable with age 90. I also know there is time between now and age 90 to make minor adjustments to bring the plan together successfully. 

Summary – Final Thoughts

Planning financially is difficult in an uncertain world. The world is full of probabilities and likelihoods, but we each live our individual, unique lives, which makes planning difficult.

Nobody wants to save and live as if they will make it to age 90 if they will pass away at age 60. The problem is nobody knows if they will be below average, above average, or average when it comes to life expectancy. 

The best any of us can do is assess what is likely, plan for the average, and adjust unique to our circumstances. Brokerage accounts are helpful for uncertainty. In a world filled with advice such as maximizing contributions to your retirement plan, you may find yourself with fewer options if you follow that advice without looking ahead. 

Knowing life is uncertain, don’t forget to invest for growth, contribute regularly, aim for 25 to 33 times your annual spending in assets for retirement, and assume you will live to at least age 90. It should put you on a reasonable path you can adjust as life changes. 

What steps will you take to plan for an uncertain world? 

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for Full Disclaimer