You Don't Need a Retirement Plan — You Need a Financial Independence Plan

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In the golden age of a "job for life," and when defined benefit pensions were the standard, all you had to do was tough it out to hit the jackpot. A mere 40 years of employment, and you struck lucky in your golden years.

Whether the idea of working in the same place for a lifetime fills you with nostalgia or horror, the reality is that those days are long gone.

Without a steady employer doing the hard work for us, traditional notions of retirement planning do not work. The alternative, it seems, is the ostrich approach, with 48% of working age Americans saying they have never even tried to calculate the amount of savings they might need for a comfortable retirement. Ignorance might be bliss in the moment, but it's no genius long term plan. So what's the better option?

What Went Wrong With Retirement?

The Employee Benefit Research Institute (EBRI) found, in their 2016 survey measuring retirement confidence, that nearly one in five American workers (19%) were not at all confident in their ability to finance a comfortable retirement. For these workers, options are limited — spend less now, work for longer, and be prepared to compromise more on the lifestyle they expect in later years. Not a happy picture.

To add insult to injury, working longer is not actually a viable option for many of us. The EBRI reported a large gap between expectations and outcome, with a massive 37% of people saying they expect to work past the age of 65, compared to the more modest reality of only 15% of retirees in 2016 who were older than 65. This is often because options to continue working later in life become limited, with layoffs and declining physical health ending working lives without regard to the size of one's pension pot.

So with working until you drop off the agenda, what can we do to improve the prospects of having a happy, and financially secure retirement?

Start Thinking Personal Financial Independence

Ironically, part of the solution might actually be to stop thinking about retirement, and replace that thought with one of "personal financial independence."

Retirement today has changed as much as working life has, meaning there is no longer a cookie cutter approach to retirement planning that can be relied upon. The answer instead is to get educated about your household finances, with a focus on achieving personal financial independence — for life, not just for your later years. Getting clued up about your money is the only way to do that.

Start Creating It

Pull your head out of the sand, and get a realistic grip on what savings you have — and what you will need to finance your retirement.

Do the Math

Work out what you will want to spend in retirement. Tools are out there to help, like this retirement calculator, which helps you calculate what you might need to save to achieve a desired financial return in future. If you don't have an idea of your goal, then planning is a whole lot more difficult.

Optimize What You Have

If you have money in 401K plans, then you're in a strong position already. But don't just assume that it's being managed in your best interests. Check out the fees, which vary wildly and through a compounding effect can whittle away your savings at an alarming speed. Once you can safely withdraw from your 401K without incurring penalties, you will be able to choose to take a lump sum if you wish, to help you achieve the magic 4% number described below.

Understand the 4% Rule

A common premise of modern retirement planning calculations is the "4% rule" which assumes that you can live happily on the growth of a savings pot, without significantly denting the principle, so long as you withdraw no more than 4% per year. This principle, put forward by Bill Bengen in 1994, has come under some scrutiny due to our current turbulent times — but as a starting point is still considered a sound measure.

Here's how it works.

Start with the amount of money you think you will need to finance your retirement lifestyle. Multiply this by 25 to get the amount of savings you need to have to make that number a reality if the 4% rule is applied.

Then sit down, because in all likelihood that number is going to be scary.

If you calculated that you would like a household income of $40,000, then the sums say you need a pot of a cool million. How hard this really is to achieve depends on your current position. If you're just setting out and don't plan to retire for 40 years, you will need to save something like $640 a month (shared out among the earning members of the household — so half that if you're in a couple), assuming a modest 5% return on your investment. If you plan to retire a lot sooner, or do not not have existing savings or 401K plans, this number might be more daunting.

If the savings you need to achieve financial independence feel unrealistic, then it's time to start thinking of the levers you have to close the gap. Earn and save more, or plan to spend less, perhaps through lifestyle adjustments or by taking advantage of geographic differences in things like cost and quality of living. Or, plan to manage your retirement as a gradual wind down, continuing to be economically active after your usual retirement age, but in a flexible role. Considering these options now, rather than being pushed into them at the point you wish to quit working, is far more likely to have a happy ending.

The new world of planning for later life brings with it more choices, but also more questions to mull over and decisions to make. Instead of facing these questions, too many of us are ignoring the issue. Experience shows that working longer (or windfalls, or a fairy godmother) is unlikely to be the answer. Getting clued up about your money now is the only way to give yourself a shot at the golden years you deserve.

What do you think? What is the optimum way to plan for your retirement now?