You can retire a little early on $400,000, but it won’t be easy. If you have the option of working and saving for a few more years, it will give you a significantly more comfortable retirement. By waiting until at least age 67, you can collect more in lifetime Social Security benefits and your retirement account will have gathered quite a bit more steam. But if there’s a good reason to retire early and if you can live very modestly, you might make these numbers work. Here’s what you need to know. You can also work with a financial advisor if you’re wanting a more personal look at what you need to retire.
Social Security and Medicare At 62
At 62 you can take withdrawals from your retirement accounts, such as a 401(k), without incurring a special tax penalty. At the time of writing, the IRS allows you to withdraw money from tax-advantaged accounts starting at age 59.5, so you can take full drawdowns. However, age 62 is still considered early retirement. Your savings will have to last longer and will have less time to grow if you start taking them out at 62.
Age 62 is also when you can begin collecting Social Security benefits. However, Social Security works sliding scale. The full retirement age is officially 67. If you retire early, the government reduces your lifetime monthly benefits proportionally. If you retire later, up to age 70, the government increases those benefits.
By retiring at age 62, the earliest you can begin collecting Social Security, you will reduce your lifetime benefits by 30%. This means that for every $1,000 in benefits that you would receive at full retirement age, you will receive $700 instead. At age 67, the average Social Security benefit is $1,782 per month, so if you retire at age 62 average benefits will pay $1,247 per month.
Finally, Medicare will not kick in until age 65. This means that, in addition to any supplemental health insurance to cover the gaps in Medicare itself, you will need full health insurance to bridge the time between your employer’s coverage and Medicare coverage.
In addition to Social Security benefits, the key question is how much you can reliably earn from your total retirement plan. With $400,000 in your 401(k), how much can you expect to draw down from that portfolio? Will it be enough to last throughout retirement starting at age 62?
The answer is, maybe. This money can generate a modest income that might be enough to pay your bills depending on your standard of living. But this will not be a generous income. It won’t leave you much room for either luxury or emergency spending.
To see how this works, let’s start with the average Social Security income adjusted for early withdrawals, which is just shy of $15,000 per year. Now, consider annual withdrawals from four separate portfolios: cash, bonds, stocks and annuities.
Note that this is simplified for the sake of demonstration. A standard retirement portfolio will typically hold a mix of assets weighted toward safe investments but with some long-term growth assets as well.
A cash portfolio means that you keep your investments in banking products like savings accounts and certificates of deposit. Generally speaking, at best these products will keep your portfolio consistent with inflation and usually not even then. We can treat this as effectively a 0% rate of return. Keeping your money in cash is not really an option here.
Using the standard 4% withdrawal rule, this would let us pull $16,000 per year from the retirement account. Combined with Social Security, this would give you $31,000 per year in pre-tax income. This isn’t much to live on and it would only last you about 25 years before your portfolio runs out. Starting at age 87, you will need to coast on $16,000 per year in Social Security benefits for the rest of your life.
For the last 20 years, bond yields have hovered around 4%. Using this as a benchmark, a $400,000 portfolio invested entirely in bonds would generate $16,000 per year without touching the underlying principal. While you would need to ensure a portfolio of bonds that actually do pay that kind of interest rate, this could ensure a functionally indefinite retirement at $31,000 per year when combined with Social Security benefits, somewhat adjusted for inflation as Social Security benefits increase.
But… that’s still not a lot of money. And unfortunately drawing down on your principal will only help a little. Remember, by retiring at age 62 you are setting up for a long retirement. This money will need to last around 40 years to comfortably ensure that you won’t outlive your savings. This means you can probably boost your total withdrawals (principal and yield) to around $20,000 per year. This will give you a pre-tax income of $35,000 per year.
When discussing retirement accounts, stocks can be tempting and dangerous. Historically the average annual return on the S&P 500 is a little over 10%. That’s why market-indexed funds are such a powerful tool for people saving up for their retirement. In retirement, this can be just as valuable. With a $400,000 retirement account, a 10% annual rate of return would give you $40,000 per year without ever drawing down on the principal.
You’d have to manage the fund, selling and buying assets to capture those gains, but combined with Social Security benefits this would give you a $55,000 per year indefinite income. You wouldn’t be rich, but that’s enough to be comfortable in many places. The problem is volatility. That 10% rate of return is the average rate of return in a highly unpredictable market. Some years you will receive much more, some years much less. In bad years you will even lose money.
Building a retirement strategy around stocks means managing that volatility. If you have the capacity to set aside money in good years to offset the losses in bad ones, then this approach might work. If not, you might find yourself riding out a recession on that $15,000 per year in Social Security benefits to avoid taking losses.
Lifetime annuities aim for the middle ground between stocks and bonds. This is a contract in which you provide an up-front investment and then the company (typically a life insurance company) guarantees you a fixed payment for the rest of your life. The contract typically pays more than bonds, but less than stocks and offers long-term security.
The earlier you invest in an annuity, the more it will pay over the long run. However, a popular approach is to invest in stocks and other growth assets while saving up, then convert your portfolio into an annuity upon retirement.
With $400,000, if you buy an annuity at age 62 and then retire, you might expect monthly payments of around $2,400 for the rest of your life. This comes to about $28,800 per year in guaranteed income according to one estimate. That’s better than bonds, but less than stocks and combined with Social Security you could expect about $43,800 per year in pretax income.
This isn’t much, but in most of the country, you can afford a modestly comfortable lifestyle with this amount of money. More importantly, you will not have to draw down on any principal. Short of the insurer collapsing with no bailout or rescue, which is unlikely, you can expect these payments to continue indefinitely. Of the options we discuss here, it is probably your best bet.
Retiring at 62 on $400,000
This plan can work … sort of. At age 62, with $400,000 in a 401(k) account, you can generate a livable income depending on how you structure your portfolio and where you choose to live.
Livable does not mean comfortable, however. This approach will not leave you much room for comfort or luxury and you might have a real problem in case of emergencies or unexpected expenses. What’s more, with this profile, you’re only a few years away from a quite comfortable retirement if you can wait just a little longer.
Say that you wait until full retirement age at 67. Invested in an S&P 500 index fund, that extra five years of investing could let your portfolio grow to more than $644,000. That could buy you a $46,000 per year annuity. Add in full Social Security benefits, averaging $21,300 per year and you can retire on more than $67,000 in annual, indefinite income.
This portfolio will allow you a tight, but possible, retirement at age 62. But it will allow you a comfortable retirement if you can hold on for just five more years.
If you have $400,000 in the bank you can retire early at age 62, but it will be tight. The good news is that if you can keep working for just five more years, you are on track for a potentially quite comfortable retirement by full retirement age.
Social Security Tips
- How you invest during your retirement really does matter. After all, these days you will likely spend several decades enjoying your life after work. That’s a lot of time for your money to grow if you can manage it well.
- 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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