Have you planned well for your retirement? Some answer that question this way: “Oh, I love my work, and I don’t plan to ever retire.” That may well be true. But what if you change your mind? Or what if something happens in your life preventing you from working well into your 70s and beyond?
Don’t neglect to plan just because you think your goal is that you will work forever. What you need is a plan — not for retirement, but for “financial independence.”
Take me, for example. I’ve always thought I would never retire. I love being a financial planner, and I figured I would do that work forever. But three years ago, the stress of the job started to catch up with me. I decided I needed some contingency plans. While I have been saving all along for retirement, what I needed was a mind-shift to start thinking about “what if.”
The computation for financial independence is the same as for retirement planning. The goal is to establish how much you must save for an adequate pot of money someday in the future. That pot of money should spin off enough income to cover all your expenses. Whether you retire and no longer work or decide to continue working, you will have your bases covered.
Living expenses are the key metric
The key metric to plan for retirement or financial independence (FI) is the amount you need for living expenses. It’s easy to get caught up in rates of return and what investments to use, but the number that moves the dial (for better or worse) is how much you spend. That should be easy, right?
It isn’t easy. If you are in your 40s now, how on earth are you going to know what your spending needs will be when you are in your 70s? The answer, of course, is that you can’t know for certain. The best you can do is estimate what you will need. There are two ways to estimate this number – one is the easy way and the other is the hard way. Of course!
The easy method is to look at your current household expenses and use the rule of thumb that most folks will need 70-80% of their current household spending for their financial independence spending. Done and done.
The harder way to do this is, of course, the better way. Look at your current household expenses. If you have created a cash flow statement, those figures will be easy to come by. The next step is to modify the expenses by removing obvious expenses that will disappear when you cease working. For example, maybe you are on track to have your mortgage entirely paid off before retirement/FI. And hopefully your children will be fully launched by then (talk about a good goal!), so any kid-related expenses can be crossed off.
You might also modify the retirement/FI expense number upward to reflect additional expenses associated with how you want to use your newly found free time. Travel and hobbies come to mind as examples. Health expenses might also increase, so include some additional funds for that unknown.
One side note here: it is critical when doing this computation to only think in today’s dollars. Do not try to assume what your expenses will be in the future. Think only in terms of today. “If I was financially independent TODAY, what would my expenses look like?” Retirement calculators will help you do the inflating later. Trying to do it now will only confuse you.
Once you have modified your expense number down (post-mortgage and kids) and potentially up (travel, hobbies, and health), apply that number as your retirement/FI expense number. Don’t further adjust it down by applying the 70-80% ratio rule.
The further away you are from your anticipated financial independence, the more buffer you need in your expense number. If you are in your 30s, for example, and plan to work until your 60s before retiring, that is a long time-horizon. In that case, I recommend using 100 percent of what you are spending now (including mortgage) as your retirement/FI expense figure.
When you have your number, you can use a simple calculator such as this one on Calculator.net to compute the pot of money needed to make financial independence a reality. Now you have a saving goal!
Lifestyles tend to stick
The lifestyle you live now is quite likely the same lifestyle you’ll have at retirement/FI. In my financial planning practice, we seldom see people who upgrade their lifestyle once they stop working. We sometimes see people slightly downgrade their lifestyle, but it is wise to not assume that you will, too. Most lifestyle downshifts are due to a big career that required expenses – such as cars, clothing, and travel – expenses that won’t be necessary once you’ve finished your career.
If you feel discouraged by the numbers you compute, remember you have a choice. One path is to live bigger now and either expect to downshift later or be forced to work harder and longer to fund your retirement/FI. The other approach is to choose to live small now in order to stockpile funds and make financial independence within reach.
We never know what the future holds, so being prepared is your best bet. Determine what your financial independence pot of money should be, and then devise a plan to get there. Don’t avoid “planning for retirement” just because you think you won’t retire. You may work until your dying day but what if you don’t? Cover the “what if” by creating a goal to achieve financial independence someday. Ultimately, when that day comes, you’ll have a choice to continue working or not. How nice is that?
How have you approached retirement or financial independence planning?