It’s easy for a country to celebrate a day of independence. There’s a clear marker—for the U.S., July 4 is the anniversary of that day in 1776 when the founding fathers voted to declare independence from England.
It isn’t so easy for average Americans to celebrate a day of financial independence. There’s not one marker, but many. What’s more, the markers vary from person to person.
“Part of the challenge is that the definition of financial independence is as unique as the individual,” said Dan Veto of Retirement Spark, a research and consulting firm. “The topic doesn’t easily lend itself to a hard and fast equation.”
Still, experts say it’s possible for those planning for or living in retirement to declare financial independence, provided they achieve most, if not all, of the following goals.
1. Set aside 11 times your salary
You need to set aside at least 11 times your final year’s salary in your nest egg to maintain your pre-retirement standard of living in retirement, according to a recent Aon Hewitt report. The good news? That figure includes inflation and post-retirement health-care costs.
Knowing that you won’t be a burden on your children is of course part of the reason for setting aside this much in your nest egg.
“Not having to rely on my children for financial support is one aspect of financial independence,” said Meir Statman, a finance professor at Santa Clara University. “This was very important to my father who supported his mother- and father-in-law when we came to Israel, penniless, in 1949.”
Don’t fret if you don’t have exactly 11 times set aside. David Laibson, a Harvard University economics professor, says you should be able to get by with 10 times your salary.
2. Match income and expenses
The experts don’t quibble about this: You’ll need enough income to cover your expenses over the course of retirement. “You should have enough income in retirement to maintain your standard of living and, with the proper estate planning, an ability to leave an inheritance to your family or charity,” said Victor Ricciardi, a finance professor at Goucher College.
Put another way: “Financial independence in retirement is not having to follow the performance of the stock market 24/7 or track interest rates on your savings to make sure you can pay your day-to-day expenses,” said Dan Keady, CFP Board ambassador and director of financial planning for TIAA-CREF.
“For many retirees, we suggest figuring out how much money you will need for fixed costs such as food and shelter, and then calculating what Social Security and any pensions will provide,” he said. “Then, annuitize enough of your nest egg to bridge the gap between those fixed expenses and what’s provided by other sources of retirement income. This provides an income source similar to that enjoyed by previous generations, who received payments from pensions that lasted as long as they lived.”
Others agree. “Financial independence is really a surrogate for independence, so this is both a philosophical and societal question,” said Larry Cohen, director of the consumer financial decisions group at Strategic Business Insights.
“Outside of being a pretty poor insulator and fire starter, money in itself has little value, but what it represents is the ability to do things,” said Cohen. “If you have your health, food, clothing, shelter, family, friends, activities, and a support network, and you had all these things but not one dollar, in many ways you are as rich as the richest person, perhaps more.”
Given that what we think of as retirement is drastically changing, perhaps you are talking about a smaller life stage—the stage past career, but before the nursing home. “To feel secure in that stage, you need to have everything set up for the final stage,” he said. “Financial independence for the new ‘retirement’ stage of post-career means enough income to cover one’s costs, enough assets to tide one over for uncertainties and occasional indulgences, enough diversification to protect one from the ravages of the markets and inflation, yet enough simplicity so that it can be managed effortlessly.”
3. Don’t worry, be happy
Don’t despair if you don’t have 11 or 10 times your salary set aside just yet or you can’t cover all your retirement expenses. Researchers at Boston College’s Center on Wealth and Philanthropy have been surveying the superrich for years now. Their findings: 75% of their survey respondents have assets of at least $25 million, yet most of them don’t consider themselves financially secure. How much would be enough? On average, about 25% more than what they already have.
“The lesson I draw from this is that financial independence is not primarily found in having more money, but in being able to find contentment in what you have,” said James Choi, a finance professor at Yale University’s School of Management.
Frank Paré, CFP, an adjunct professor for the personal financial planning program at the University of California at Berkeley and the president of PF Wealth Management Group, shares Choi’s point of view. He says many individuals want to give back during their retirement years but they also don’t want to be a drain on their families.
“They want to be able to choose how they live and pursue their passions without the burden of having to work full time. They talk more about their quality of life and their values when it comes to investing. Consequently, this quality-of-life and values conversation is what motivates them to change current financial habits that might be detrimental to their choices down the road,” he said.
Annamaria Lusardi, an economics professor at George Washington University’s School of Business, views it even more simply. “Enjoy time with family and friends because, as we Italians like to say, ‘Life is short, more so when old,’” she said.
4. Retire debt-free
If possible, enter retirement debt-free. No mortgage, no car loans, no credit-card debt. “What greater independence can there be than not having to send a hefty check to the bank every month?” asked Brigitte Madrian, a professor at the Harvard Kennedy School.
Others share that point of view. “Retirement should be when one decumulates wealth. It is not wise to hold assets earning 1% and paying 25% on credit-card debt,” said Lusardi.
Lukas Dean, an assistant professor at William Paterson University, offered these words of wisdom: “Although there are some valid reasons that financially savvy individuals might intentionally retire with a mortgage, to be truly financially independent you would have to be debt-free. Debt is a form of bondage.”
Dean, paraphrasing a famous quote from J. Reuben Clark, said: “Those who understand interest, earn it. Those who don’t, pay it.” There are exceptions to this rule, but it has proved to be quite true, Dean said.
5. Companionship matters
Research suggests that the most important factor to financial independence is having good companionship—a spouse, family and friends, according to John Helliwell, a professor emeritus of economics at the University of British Columbia who edited the World Happiness Report.
Being married is high on the list. “Marriage is one of the unambiguous, universally positive and statistically significant correlates of life satisfaction,” according to that report. “Basic estimates of happiness always reveal that being married rather than single, divorced or widowed, is strongly associated with higher self-declared happiness.”
Helliwell says the other factors associated with financial independence in order of importance are good health; basic financial security (sufficient to cover health care and other necessities); something interesting to do (ideally with and for others); access to mutually supporting family and friends; and some extra financial leeway, for peace of mind and the odd something special for self or others.
6. Stay in good health
Research also shows that retirement satisfaction is a function of three things: retiring on your own terms, being in good health, and being married. It might be hard to control whether you retire on your own terms or even whether you are married. But it’s well within your control to stay as healthy as possible before and during retirement.
“Having good health in retirement gives you greater independence to do the things that you want to do and to live where you want to live, which is an important factor for many older individuals,” Madrian said.
7. Manage risks
Retirees “need enough downside protection to be independent and able to feel carefree and easy,” Dean said.
“There are a large number of risks that you would need to be protected from,” Dean said. “In addition to the usual suspects like health, property, liability, and life insurance, you would also want to have a plan in place for longevity risk, disability, long-term care, and any unexpected changes in family such as death or divorce and any unexpected market changes.”
The Society of Actuaries has identified at least 15 potential retirement risks. At a minimum, you should review those risks and address as many as possible.
8. Cover health-care expenses
Even if you are in good health, make sure your health-care expenses are covered either out of assets or through insurance or both.
Dan Ariely, author of “The Honest Truth About Dishonesty” and a behavioral economics professor at Duke University, says knowing out-of-pocket health-care costs in retirement and knowing they are covered is part of being able to declare financial independence.
Make sure you have generous health-insurance coverage, either retiree coverage from a former employer or a Medigap policy so that out-of-pocket health-care expenses aren't a concern.
In addition, consider having long-term-care insurance, either in the form of an insurance policy or a nest egg sufficient to cover several years in a nursing home should that circumstance unfortunately arise, said Madrian.
9. Do something
Whether it’s for pay or not, find something to do in retirement. Don’t just sit there. Yes, tend to your garden and grandchildren. But keep busy. And no matter what, don’t just stay in a job you hate.
You want “freedom from being ‘trapped’ in a job that only provides health benefits or income and not satisfaction, meaning and a sense of contribution,” said Marty Martin, author of “The Inner World of Money: Taking Control of Financial Decisions and Behavior.”
John Nelson, co-author of “What Color Is Your Parachute? For Retirement,” looks at the notion of working in retirement a bit differently.
“When it comes to financial independence, we can get caught in ‘all-or-none’ thinking,” Nelson said. “Especially for our jobs, we think that financial independence means not working at all. If our work is drudgery, then of course we’d like to have none of it.”
But there is a middle path. “We can become financially independent enough to work at something that’s easier and more fun,” he said. “Or something that’s still challenging, but more fulfilling. Especially if financial independence is out of reach, then it’s important to explore the middle path between ‘all or none.’”
Being able to work in retirement doing something you enjoy can be one marker of financial independence. But so too is not working. “The best part about retirement is that you are now free from 40+ hours a week of obligations that you have had for the last three to four decades,” said Dean.
A Gallup poll in November 2011 suggests that over 70% of Americans are “not engaged” or are “actively disengaged” from their work.
“Retirement brings with it the freedom from the daily grind and the opportunity to do whatever hobbies and passions you have had to abdicate or neglect in order to practice your profession,” said Dean.
10. The kitchen sink
There are plenty more markers. Here are some others worth noting.
Don’t stop saving even if you have saved 11 times your final salary for retirement. According to Dean, saving even more gives you a cushion, a margin for error and, most of all, peace of mind “that you are financially stable and independent.”
Peace of mind and financial independence also comes from having an empty nest, according to Madrian. “If your children have graduated from college and fully transitioned to independent living” that’s a good thing.
Consider yourself financially independent, too, if you have a plan for worst-case scenarios. For instance, if your town has a really bad week, “you will want to have an emergency supply” of nonperishable food and water, said Dean.
Last, though not least, being able to give back to others is yet one more sign of financial independence.
“Financial independence in retirement is having the resources—the time, money and the like—and the ability to choose to help those who are less fortunate without having to worry or rely upon someone to help you,” Paré said.
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