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How to Save for & Spend in Retirement

January 24, 2018 | Craig Birk, CFP®

You are the CEO of your money – at the end of the day, managing your money is your job, and you’ve got important decisions to make. Your ability to manage finances is critical to determining what your future will look like. One big part of this is figuring out where you should save and how you should spend in retirement.

Where Should I Save?

Unless you inherit or marry money (or win the lottery), there are only two ways to afford retirement: Get a job that offers a good pension, or save and invest.

Assuming the latter applies to most of us, the next question is: where should you be saving? Generally, the primary choices of accounts and investment vehicles available include tax-advantaged retirement accounts, taxable brokerage accounts, bank accounts, physical property, or paying down debt. With so many potential variables, it’s impossible to offer hard rules that will apply to everyone. However, we generally recommend the following:

7 Tips to Save Money

  1. Pay off any high-interest debt first.
  2. If your employer offers any kind of matching contribution to your 401k, then you should save at least up the amount matched.
  3. If no employer match is available, you should try to maximize savings in tax-advantaged retirement accounts before saving in taxable accounts. These include accounts like traditional and Roth 401ks and IRAs
  4. If you have kids, it usually makes sense to open one or more 529 accounts which cover education-related costs. But only do this if your other tax-advantaged retirement account contributions are maxed out. Remember, you can borrow for school, but you can’t for retirement!
  5. A primary home can be a wonderful investment – the leverage of a mortgage and the tax benefits of the interest deduction usually make buying a home a good idea, as long as you can afford it and plan to live in it for at least six years.
  6. Speaking of buying a home, we don’t usually recommend paying off your mortgage if you have a rate under 4.5% (unless you have a stock portfolio larger than the value of your home). If you don’t have the stomach for stocks, however, then maintaining a mortgage and simultaneously holding a significant amount of lower yielding cash or bonds is simply throwing money away. In this case, go ahead and pay off the mortgage.
  7. While second homes and rental properties can be good investments, they’re not for everyone; keep in mind that a second property that isn’t rented out should be considered consumption, not an investment.

How Should I Spend?

Once you’re retired, adhering to the right spending level is one of your most important financial responsibilities. Spend too much and you risk running out of money. Spend too little and you will miss out on valuable life experiences. There is a complicated whirl of variables and “what if?” scenarios that will have a direct bearing on your spending level.

Questions for Retirement

Here are some good questions to ask yourself when it comes to spending in retirement:

  • When do I want to retire?
  • How long will I live?
  • What about my spouse?
  • How much will healthcare cost?
  • Will I move?
  • How much do I want to leave behind?

Your Withdrawal Rate

From an asset management perspective, the spending question is usually framed in terms of one’s “withdrawal rate,” which is the amount spent from your investment portfolio each year as a percentage of the total portfolio value. Typically, it is assumed the original withdrawal dollar amount remains constant, except for an annual inflation adjustment.

Your goal should be to find a withdrawal rate that balances your lifestyle needs with a minimal (or at least acceptable) risk of running out of money. Like many things in life, luck and timing play a big role in your financial success in retirement. These factors may be beyond your control, but regardless of how they play out, it’s up to you to exercise control where you can. Establishing and maintaining a disciplined withdrawal strategy for your retirement will substantially increase your odds of success.

An industry rule of thumb – the 4% Rule – suggests that balanced portfolios will not run out of money if the withdrawal rate is limited to 4% annually. Withdrawals are not adjusted for market returns. You can perform a rough estimate of your retirement planning position by using this rule.

Don’t Forget Health Care

Another area of spending many people don’t think about is health care. The average couple retiring at 65 will spend about $275,000 on health care over the course of their retirement. These expenses can come in the form of long-term care. Medicaid laws ensure that you will not be thrown out on the street if your assets are depleted because of long-term care costs. In fact, it may be worth planning to make use of this government insurance policy if/when the need arises, rather than sacrificing too much consumption early in retirement to plan for expenses that may never occur.

To learn more about saving for and spending in retirement, as well as three steps to managing your money overall, read our free Personal Capital Guide to a Better Financial Life.

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