Most of the time, we talk about retirement planning in relation to goals, lifestyle and how to build the wealth to maintain that lifestyle in retirement. But there’s another way to looks at things. Once you reach retirement age, what can you do with what you have? Based on your savings, benefits and other assets, what kind of income can you sustainably generate?
Hopefully, these goals and capabilities align. With any luck, your retirement assets will pay for a long, comfortable lifestyle. Either way, this second analysis is important. You can’t just assume that your savings will pay for the retirement you have planned. Before you stop working and start taking withdrawals, it’s a good idea to run the numbers to make sure your portfolio meets your plans.
For example, let’s say you’re 65 years old. You have $780,000 in a 401(k) and expect to receive $1,900 per month in full Social Security benefits. Can you retire and, if so, what kind of income can you expect?
Here are some things to consider. If you need further guidance, consider reaching out to a financial advisor.
Calculate Your Retirement and Social Security Age
First, you’ll want to consider when you plan to retire, as your retirement age will matter a great deal.
Although culturally the retirement age is arguably 65, you can’t collect full Social Security benefits until age 67. So this gives us five possible retirement ages to keep an eye on:
- Age 59.5: The earliest you can take money from your retirement account
- Age 62: The earliest you can start receiving Social Security benefits
- Age 65: The cultural idea of retirement age
- Age 67: When you can receive full Social Security benefits
- Age 70: When you can receive maximum Social Security benefits
If you take Social Security before age 67, your benefits will be permanently reduced by either 0.55% or 0.416% for each month that you collect benefits early. If you begin taking benefits at age 62, you will receive 70% of your full benefits for the rest of your life. If you delay taking benefits after age 67, your benefits will be permanently increased for each month that you wait up to a 24% increase at age 70. At age 70, you’ll automatically begin receiving Social Security payments, and will receive the maximum benefits for life.
In our example, let’s assume you expect to receive $1,900 per month if you retire at age 65. This means that your full benefits at age 67 would be approximately $2,153 per month or $25,839 per year (5/9 = 0.5556% * 24 months = 13.332%). So then your benefit at 65 would be 86.667% (100% – 13.332%) of your benefit at full retirement age. At 67, your benefit would be approximately $2,192. At 70 your maximum benefit would be approximately $2,718 per month or $32,040 per year.
We’ll want to perform the same math with your retirement account.
In our example, we’re assuming you have $780,000 in your retirement account at age 65. If you choose to retire later, that number could be higher. For example, say that your portfolio has an 8% average rate of return (the average for a mixed-asset portfolio). By age 67, this portfolio could grow to around $910,000. By age 70, it could be worth $1.14 million. These numbers will depend on how you have your money invested, and the portfolio’s actual performance.
This can swing your analysis significantly. For example, at age 65, you would retire with $780,000 in your 401(k) and $1,900 per month in benefits. However, at age 70, you might retire with $1.14 million in your 401(k) and $2,670 per month in benefits.
Tax and Spending Considerations
The next thing to take a look at is your budget. This means considering both your household needs and your tax situation.
From the perspective of household needs, start with your current budget. A good rule of thumb is to assume that, in retirement, you will need about 80% of your current income. This rule of thumb assumes that you save around the average 10% each year. Households that are much more aggressive about their saving can estimate lower, but 80% is a good place to start.
So, for example, say that you make the median household income of around $78,500. In that case, you would plan to need around $62,800 per year, or $5,234 per month in retirement.
From there, consider your retirement-specific needs. This will include setting aside extra money for health insurance needs such as Medicare premiums, gap insurance (to cover the needs that Medicare doesn’t) and long-term care insurance. Look at your current budget and consider how well you can accommodate some extra spending on insurance issues, to make sure that you have room for those new needs once you retire. A financial advisor can also help you assess your needs and create a plan.
Then, there are tax considerations.
One issue that many people forget when planning for retirement is that, with most portfolios, retirement income works like ordinary income. You don’t get to spend everything you take out, just whatever is left after taxes. So your retirement plan will depend considerably on your portfolio’s tax status.
If you have a pre-tax account like a 401(k) or a traditional IRA, you will pay income taxes on all withdrawals, including principal and returns. For example, to generate $62,800 per year of after-tax income, you would need to withdraw around $78,000 per year (not accounting for state or local taxes if applicable).
If you have a taxed account, meaning that you hold this money in an ordinary portfolio with no special tax preferences, then you’ll either pay capital gains taxes or income taxes on the returns from your withdrawals. The details of these taxes will depend on the nature of any individual asset.
If you have a post-tax account, meaning either a Roth IRA or a Roth 401(k), then you won’t pay any taxes on your withdrawals. To meet that $62,800 per year of income, for example, you would only need to withdraw $62,800.
Consider speaking with a financial advisor if you’re interested in building an appropriate withdrawal strategy.
Will Your Portfolio Last?
This brings us to the question at hand. If you’re 65 years old, have a $780,000 retirement portfolio and expect $1,900 per month ($22,800 per year) in Social Security benefits, can you retire?
As we’ve discussed, the answer isn’t as simple as yes or no. Sure, you can retire. You can retire at any time you choose. But we can’t ignore the nuance:
- If you retire right now, at age 65, will your benefits and after-tax portfolio income reliably maintain your standard of living? Can you sustainably pay for your lifestyle and needs with what you have?
Let’s examine this further, starting with the basics. The rule-of-thumb approach to retirement is called the 4% rule. This means that you plan to withdraw 4% of your portfolio each year in retirement, and plan on a conservative investment strategy to offset inflation. Here, that would give you about $31,200 per year from your portfolio, for $54,000 in combined pre-tax income and about $50,000 in after-tax income. (Technically, this will be a little higher since you will only pay taxes on 85% of your Social Security benefits, but this is a reasonable estimate.)
That said, many financial advisors believe that the 4% rule is too conservative. Taking into account that corporate bonds have averaged around a 5% yield, you can maybe see where they’re coming from. So, say you use that as a benchmark. You withdraw $40,000 per year, for a combined pre-tax income of $62,800 with your Social Security benefits. With this approach, your portfolio would likely last about 24 years, taking you to age 89.
This could be risky. The average retiree lives to around 88 years old, which means that about half the population will exceed that life expectancy. You don’t want to plan for a retirement that will end in your late-80s, because that creates a good chance that you’ll outlive your savings.
Realistically, if you retire at age 65 with this profile, you would likely need an average annual return between 6% and 7% in order to sustainably account for longevity. And even that assumes that you only need $62,800 per year of pre-tax income to maintain your standard of living. If your portfolio returns less than this (reasonably likely) or if you need more money, you’ll exhaust your savings.
So, it might be possible for you to retire at 65, but only if we make some generous assumptions. The good news is that you’re probably on track for a comfortable retirement in just a few more years. If your portfolio grows and you wait to collect full benefits, and you’ll most likely have that margin for error that your current plan is missing. A financial advisor can also help you assess how close you are to being on track.
Bottom Line
At age 65, it’s wise to look at exactly what kind of retirement your portfolio can pay for. You still have several years left to keep working, and it might be well worth waiting just a little longer to make sure your retirement is foolproof.
Tips for Managing Your Portfolio in Retirement
- If retirement is here, but your savings aren’t, you don’t need to panic. There are a lot of strategies that stretch savings you can use to make sure your money goes the extra mile.
- 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 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.
- Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
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