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For households with very little saved, there is a rulebook. A tight retirement requires you to restructure your spending, maximize Social Security and delay withdrawals as late as possible. For households with significant savings, there’s another set of rules. You want to manage your wealth, plan for your estate and minimize taxes.
With $850,000 in retirement savings, a hybrid approach to retirement planning may be most impactful, depending on your personal circumstances. You can’t ignore spending and taxes, or this money may not last on its own. On the other hand, you probably don’t need to cut your luxuries and lifestyle to the bone. This is a retirement all about balance.
Say that you have $850,000 in your 401(k) and are approaching retirement. What’s the plan to help make sure it lasts, while living the most comfortable situation possible? How you treat this retirement account can make a big difference.
Here are some important things to consider. You can also use this free tool to match with a fiduciary financial advisor if you’re interested in talking your plan over with a professional.
The first question here is, when do you plan on retiring? This is a bigger deal than it may seem.
One of the least-appreciated aspects of retirement planning is that the last few years of your working life are, financially, usually the most important. This is the era when your retirement account has hit its maximum compounding value, meaning that each additional year of work generates the most additional wealth for the long run, pending market conditions. At the same time, you are also most likely in your peak earning years, letting you maximize your contributions to all forms of savings.
For example, let’s say that you’re 67 making $150,000 per year (double the national median). At a savings rate of 10% per year, this gives you $15,000 per year of retirement contributions. Add in a full employer match and you have $30,000 per year.
If you retire today, you will have $850,000 in your 401(k) account. However, with this profile, you could work a little longer and keep allowing this portfolio to grow. Say you waited three more years and retired at age 70. With a mixed return of 8% (common for a mixed bond/stock portfolio) and $30,000 per year of additional contributions, you might have $1.16 million in savings.
That is a significantly more generous retirement plan.
The point of this is not to say that $850,000 isn’t enough. Rather, it’s to emphasize that when you choose to retire is essential.
Social Security is the next big issue.
For most retirees, your total income is a combination of Social Security payments plus portfolio withdrawals. So any plans will depend on your Social Security, and how much money you need after each month’s benefits income.
Currently, the average monthly benefit for a retiree is $1,907 per month, or $22,884 per year. Let’s call that your full benefit if you retire at 67. This means that if you are 67 today, you can count on an inflation-adjusted income of $22,884 per year for the rest of your life.
You can also choose to delay collecting your benefits, which will increase your lifetime payments by 8% per year to a maximum 124% at age 70. This would generate a maximum guaranteed income of $28,376 per year for life depending on how long you wait for retirement.
This brings us to the heart of the issue. To decide what you should do with your portfolio when you retire, we need to start by figuring out your potential retirement income. Much of that will depend on when you choose to retire and when you choose to collect Social Security benefits.
For example, let’s assume with a basic bond portfolio, which many retirees opt for due to the lower risk profile relative to securities (stocks). Based on averages over the last 25 years, this might generate a 5% fixed rate of return. We will very conservatively budget for a retirement lasting until age 100. Median life spans at retirement are around age 87, but we want to account both for improvements in medicine and outliving the average. After all, about half of us will beat any given median and we want your 95th birthday to be good news.
If you retire at age 67 with a 33-year plan, you might expect an income of:
Portfolio: $50,000 + Social Security: $22,884 = $72,884 per year
If you retire at age 70 with a 30-year plan, you might expect an income of:
Portfolio: $72,000 + Social Security: $28,376 = $100,376 per year
On the other hand, you might take a more aggressive approach to retirement. Some financial advisors may suggest that retirees should invest for more growth to offset inflation and longevity. In this case, you might invest toward a mixed-portfolio return of 8%, balancing your bonds (average return 5%) with the S&P 500 (average return 11%). Now, this approach would require a greater flexibility around risk. You would need the ability to adapt in down years, either with an emergency fund or spending cuts. However, in this case you might expect the following income at age 67:
Portfolio: $70,000 + Social Security: $22,884 = $92,884 per year
Now, these are just three examples. You have many options, including the traditional 4% plan (withdraw 4% of your portfolio per year) or using your entire savings to buy a lifetime annuity (maximizing security, but increasing inflation risk).
In all cases, however, the key question is how well these numbers meet your personal needs, and how much risk are you comfortable with. For example, each of these examples above would generate a comfortable income for a household that lives on the national median income of $77,500. However, if you have gotten used to a standard of living at $150,000 per year, you might have a harder time making this budget work.
A financial advisor can help you make integrated retirement calculations based on your personal circumstances.
Anticipating your needs and budget in retirement will involve a number of different concerns.
First and foremost, of course, is your spending itself. What do you need to spend each month and year to maintain your lifestyle? How does that meet your income? If the numbers are modestly off, are there parts of your lifestyle that you can comfortably adjust, or would it be easier to adjust your retirement plan? If the numbers are significantly off, is it possible to move to an area with a lower cost of living or otherwise make big changes?
While you are at it, make sure to plan for taxes.
With this profile, it’s unlikely that you need to worry about RMDs. Your 401(k) withdrawals for income will almost certainly exceed your minimum distributions. For example, even if you still have $850,000 in your portfolio at age 73 you would only have a minimum distribution of around $32,000. This is likely less than you will withdraw in a normal year.
Now, if you find your spending very light, you will want to keep an eye on this. More or less if you notice yourself withdrawing less than $40,000 per year from your 401(k), double check your distribution requirements. Otherwise, this is unlikely to be an issue.
Taxes, on the other hand, will be an important part of your budget.
When you calculate retirement savings, it’s easy to overlook income taxes. However, except for a Roth account, you will generally owe standard income taxes on all pre-tax portfolios, capital gains taxes on all taxed portfolios, and modified income taxes on Social Security benefits. This can significantly reduce your spendable income, especially once you account for state and local taxes.
For example, say you live in New York City. On a retirement income of $72,884 you might expect to pay around $14,089 in combined federal, state and city taxes. (This would be somewhat adjusted for the modest break you get on Social Security taxes.) This would leave you with $58,795 of actual spending to live on.
Make sure to budget for this. Otherwise you might have an unpleasant surprise come your first year off work. Consider speaking with a financial advisor who can help you navigate the many considerations necessary for a robust retirement strategy.
As you approach retirement, it’s important to begin making a specific plan for how you will turn your savings into income. This requires budgeting, planning and careful thought about how and when you intend to retire.
We cannot overstate it: financial planning does not end in retirement. With that in mind, here are six financial planning tips for retirees.
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.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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