Do you have enough money to retire?
There are many different ways to look at this, but the most common is to break it down simply: money in vs. money out. How much income can you generate from your retirement planning, and how much will you need to spend?
Here, say that you have $1 million in a 401(k) or IRA, and expect to receive $2,500 per month in Social Security payments, a number right in the mid-range of possible benefits. Can you retire at 65?
Well, it certainly depends on your standard of living. But for most people the answer is yes. This should be enough to generate a comfortable income in most parts of the country. Here’s how to think about it. (And if you need help planning your own retirement, consider matching with a financial advisor.)
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Calculating Income Needs in Retirement
The first prong here is income. How much money can you expect from your combined savings and Social Security? Since we already have a sense of Social Security income, how much money will $1 million in a pre-tax account generate?
The exact answer depends on how you manage your money in retirement. To understand that, let’s look at four possible options for investment: cash, bonds, stocks and annuities.
But first, we have to consider the all-important issue of longevity risk.
As The Hill recently noted, most people underestimate how long they will live and, therefore, how long their retirement will last. In fact, most people expect the average American to live to between 75 and 80, which life expectancy is actually 82 for a man and 85 for a woman.
The bottom line is that you want to make sure your money lasts for at least as long as you’ll live, and most people tend to underestimate that number. So, if you retire at 65, plan for a retirement that will last at least 30 years. Preferably longer, if you can. After all, you want your 100th birthday to be good news.
You also want to consider the savings and investment vehicles your portfolio is in, as it will affect your rate of return and therefore income throughout retirement. Talk to a financial advisor to build a portfolio to suit your specific needs.
Cash: Holding your money in cash means keeping it entirely in depository accounts or similarly situated products, like a savings account or a certificate of deposit. There are many issues here, but the biggest is that even at the Federal Reserve’s benchmark rate of 2%, these accounts typically underperform inflation. This means you will lose spending power over time.
With cash, and assuming a 30 year retirement, you can expect to withdraw about $2,700 per month. ($1 million / 30 years = $33,333 / 12 months = $2,777) With your $2,500 in Social Security, this would give you about $5,200 per month to live on. This is a reasonably comfortable income in most parts of the country, although it would also have a hard end-date. Starting at age 96, you will have to live on Social Security alone.
Bonds: Bonds are often the preferred option for retirees. They generate a modest rate of return and are about as safe as you can get short of a depository account. They also generate interest-based returns, meaning that with enough invested in bonds you can live off the yield alone without drawing down on your principal. While this will trigger a higher tax rate than selling assets for capital gains, it also provides a significant measure of security. If you can live off the yield of your bonds, you can maintain this account indefinitely.
At the current Treasury rate of 4.3%, a $1 million portfolio would generate about $43,000 per year, or roughly $3,500 per month. With your Social Security payments that would generate about $6,000, again enough to live comfortably in most places. You could supplement it by drawing down on the principal, calculating a steady rate of withdrawal, and you would need to account for buying new assets as your bonds matured, but otherwise this is a source of income largely insulated from longevity risk.
Stocks: The S&P 500 has a historic return of around 10% per year. For someone holding $1 million in assets, then, a simple index fund would theoretically throw off about $100,000 per year in returns. On paper this means you could generate $100,000 per year, or $8,300 per month pre-tax, without ever drawing down on the principal. With your $2,500 in Social Security this would come to a very generous $10,800 per month, though taxes may affect your bottom line.
The problem is volatility. That 10% rate of return is an average. Some years the market does much better, some years much worse. Some years it takes active losses. You would need to have the financial flexibility to make few, or even no, withdrawals during down years or else sequence risk would cripple your portfolio. Few retirees can do this, making stocks a poor chose for most people while in retirement.
Annuities: “If a retiree wanted the highest guaranteed income possible,” Mark R. Hayes, CFP®, Founder of Infinitive Wealth Advisory told SmartAsset, “she could simply push her savings across a table to an insurance company in exchange for a SPIA, or single premium immediate annuity. This type of account acts like a traditional pension wherein the income will be paid until the death of the retiree, although one of the main drawbacks is that the retiree is forfeiting any control over their nest-egg.”
Annuities can be surprisingly lucrative and, like with bonds, they effectively eliminate longevity risk. As Bryan M. Kuderna, CFP®, author of What Should I Do with My Money?, calculates, a $1 million annuity purchased at age 65 could pay you $75,000 annually, or $6,250 per month. With your Social Security payments, this would come to $8,750.
It’s important to understand that these are hypotheticals. Other than the annuity option, it’s rare (and inadvisable) to hold all of your money in a single asset. The point is simply to illustrate what kind of monthly income $1 million is capable of generating.
Calculating Your Spending Needs for Retirement
The question is what “comfortable” looks like, because the second part of this is the spending side. How much money will you need in retirement? Making this budget is essential because you need to know if your savings can meet your needs, and if your lifestyle can fit your savings.
“Leading up to retirement, we encourage clients to take an honest look at their spending,” Kuderna continued. “Don’t cut your projected expenses short, lifestyle doesn’t magically become less expensive after a certain age. Running a budget of fixed expenses with an additional miscellaneous buffer is critical. As I often tell clients, in retirement everyday is Saturday, so the miscellaneous expense may be higher than expected.”
This last is a particular risk.
Many people plan for retirement by assuming that their costs of living will simply fall. They imagine a more modest life, one with fewer financial needs. To a certain extent that’s true. You’re unlikely to have childcare or college costs, for example, and you no longer need to budget for the monthly contributions to your retirement accounts (although that should be replaced by a monthly savings budget).
But don’t make unrealistic assumptions. You will want to enjoy your life, not remain indefinitely stuck to a harsh budget that you drew up at age 47. Among other costs, honestly look at:
A financial advisor can help you map your retirement and reach your financial goals. Match with an advisor today.
Just as in any good budgeting, you’ll need to weigh your portfolio and income potential against your needs and wants, and build in a comfortable buffer for the unexpected. You have $1 million in an IRA and $2,500 in Social Security benefits. That’s enough money to retire for some people, but make sure you plan for what your needs will be and how that will fit your budget.
IRA Investment Tips
Building a $1 million IRA is quite an accomplishment. And the first step is understanding… what the heck is an IRA in the first place?
A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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