Imagine that you’re 60 years old with $800,000 in retirement savings and $4,000 in monthly living expenses. However, you want to wait until age 65 to claim Social Security, so you need to find a way to generate additional income for five more years.
Whether you plan to delay Social Security or not, a financial advisor can help you build a retirement income plan to meet your needs.
A 4% withdrawal rate would provide $32,000 annually from the $800,000, leaving a $16,000 gap each year. Social Security benefits will likely fill that gap, but not for another five years. One option for covering the shortfall is to take strategic early withdrawals above 4% for five years, then reduce your withdrawals to replenish your savings after you start taking Social Security. You could also buy a temporary annuity that pays $48,000 for five years. Here’s a closer look at these potential options.
Retirement Funding Fundamentals
The basic challenge of funding retirement is generating sufficient income to cover regular living expenses. With $4,000 in monthly costs, your retirement funding challenge calls for $48,000 annually. The 4% safe withdrawal guideline proposes that retirement savings can safely produce 4% income per year, adjusted upwards annually for inflation, with little risk of depletion over a 30-year retirement. In your case, 4% of $800,000 is $32,000 – $16,000 less than you need. Rigidly applying the 4% guideline isn’t going to get it done this time.
Once you start receiving Social Security benefits, the income and expense gap likely will disappear. The average Social Security retirement benefit at the end of 2023 was $1,860 per month but let’s assume you’ll collect $2,000 per month at age 65 for simplicity’s sake. Your exact benefit will of course vary depending on several factors, including your past earnings record. However, if we assume a $2,000 monthly benefit, Social Security will likely more than adequately fill your living expenses shortfall of $16,000 a year.
But if you need additional help building a retirement income plan to ensure you can meet your monthly expenses, consider speaking with a financial advisor.
Funding Your Retirement
Now you have to figure out how to cover the annual shortfall between ages 60 and 65.
One option is to simply withdraw $4,000 per month from your retirement savings. Then, once you start taking Social Security, you can withdraw less from your savings in hopes that your investment earnings will replenish what you’ve taken out.
For example, you could withdraw $48,000 annually, or 6% of $800,000, for the first five years. This allows full spending with no lifestyle change. After Social Security payments start in year six, you could reduce your withdrawals to 3% to let the savings recover and grow.
Assuming a conservative 5% average annual rate of return for your savings, the $800,000 would drop to about $750,000 after five $48,000 withdrawals and five years of market growth. With Social Security now in the income mix, you withdraw only 3% of your savings starting in year six. Assuming the same 5% return on investment, at this more modest withdrawal rate over the next five years your savings account will return to and even exceed the original $800,000 balance. After that, you can opt to take 4% withdrawals and enjoy additional income with long-term security or let the account continue to grow.
Then again, withdrawing a static $48,000 per year likely won’t be enough to keep up with your expenses, since inflation pushes the cost of goods and services up each year. As a result, you may need to tweak your withdrawal rates to meet your income needs, which would deplete your savings at a slightly faster rate.
This strategic early withdrawal approach is not the only way you could go. For example, you could purchase a temporary 6% annuity paying the needed $48,000 for only the first five years. You could also work part-time to generate additional income or cut your living expenses temporarily. A financial advisor can help you determine whether an annuity is a suitable option for your unique needs.
Retirement Funding Risks
Higher withdrawals early in retirement provide essential income at the cost of draining principal faster and increasing the risk that your account will run out of money while you are alive. Even if higher withdrawal rates are only temporary, your retirement savings may not capture assumed returns. If investment performance lags, accounts may not fully return to their previous levels.
Health is another concern. It can be hard to predict your future health status, but you very likely will have to pay for private health insurance premiums before you become eligible for Medicare at 65. Out-of-pocket costs for this could run thousands per year.
Annuities, meanwhile, guarantee income but pose additional problems. For one, when you buy an annuity you lose control of how funds in the account are invested. Annuities are also complex and don’t keep up with inflation. Products vary widely in features, fees and the financial strength of the backing insurers. You may not be able to find an annuity with the required combination of return, cost and issuer stability.
Your life expectancy is another hard-to-predict variable. If you live long enough, the chances of your savings going dry may increase. And as mentioned above, inflation-driven price hikes could make your expense projections off the mark. If your strategies to produce additional income fall short, you may have to reduce spending at some point. However, pairing an $800,000 IRA or 401(k) with Social Security benefits would likely support greater consumption than $4,000 per month. But if you need help planning for various risks in retirement, consider connecting with a financial advisor using this free matching tool.
Bottom Line
With $800,000 in savings, you can probably cover $4,000 in monthly living costs. However, retirement accounts alone cannot safely sustain that spending for a 25- or 30-year retirement. To align cash flows and balance risk, you could fund five years of retirement by increasing your withdrawal rate from savings, letting accounts rebound afterward. Or you could use some of the $800,000 to purchase a temporary annuity paying $48,000 for five years only.
Either way, once Social Security payments start, your total income should be able to cover ongoing costs, assuming your monthly expenses don’t dramatically increase. However, consider making contingencies for market volatility, lower Social Security benefits, rising prices and other risks.
Retirement Planning Tips
- It takes decades of hard work to be able to afford retirement. Estimating how much you’ll need to support your lifestyle in retirement is a critical piece of the puzzle. Luckily, SmartAsset’s retirement calculator can help you project how much you’ll need to have saved up to afford retirement and whether you’re on pace to hit that target.
- Consider meeting with a financial advisor to review your retirement plan. An advisor can run projections and scenarios to help you optimize your retirement withdrawal strategies and make your money last. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one 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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