Do you have enough money to retire?
There are different ways to look at this, but the most common way to break it down is simply: money in vs money out. How much income can you generate from your retirement plan, and how much should you spend?
Here, say you have $1 million in a 401(k) or IRA, and expect to receive $2,500 a month in Social Security payments, a number that is right in the middle of your potential benefits. Can you retire at 65?
Well, of course it depends on your standard of living. But for many people, the answer is yes. This should be enough to generate a comfortable income in most countries. Here’s how to think about it. (And if you need help planning your own retirement, consider matching with a financial advisor.)
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 will $1 million in a pre-tax account generate?
The exact answer depends on how you manage your money in retirement. To understand, let’s look at four options for investment: cash, bonds, stocks and annuities.
But first, we must consider the most important issue of longevity risk.
Longevity Risk
As The Hill recently noted, most people underestimate how long they will live and, therefore, how long they will retire. In fact, most people expect the average American to live between 75 and 80, which is a true life expectancy of 82 for men and 85 for women.
The bottom line is that you want to make sure your money lasts at least as long as you’re going to 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. Longer, if you can. After all, you want your 100th birthday to be good news.
Portfolio Considerations
You’ll also want to consider your portfolio’s savings and investment vehicles, as they will affect your rate of return and therefore your income during retirement. Talk to a financial advisor to build a portfolio that fits your specific needs.
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Cash: Holding money in cash means keeping it all in a deposit account or similar product, such as a savings account or certificate of deposit. There are many problems here, but the biggest one 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 30 years of retirement, you can expect to withdraw about $2,700 per month. ($1 million / 30 years = $33,333 / 12 months = $2,777) With $2,500 in Social Security, this would give you $5,200 a month to live on. This is a fairly comfortable income in most countries, although it will also have a difficult end date. Starting at age 96, you must live on Social Security alone.
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Bond: Bonds are often the preferred option for retirees. They generate a low rate of return and are almost as safe as you can get in a deposit account. They also generate income based on interest, which means that with enough invested in bonds, you can live off the returns without drawing down 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 bond yields, you can keep this account indefinitely.
At the current Treasury rate of 4.3%, a $1 million portfolio would return approximately $43,000 per year, or approximately $3,500 per month. With Social Security payments coming in at about $6,000, that’s more than enough to live comfortably in most places. You can increase it by calculating the principal, calculate the total withdrawal rate, and you have to account for the purchase of new assets as matured bonds, but using this as a source of income is generally isolated from the risk of longevity.
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Shares: The S&P 500 has historically returned around 10% annually. For someone with $1 million in assets, then, a simple index fund would theoretically return about $100,000 a year. On paper, this means you could be earning $100,000 a year, or $8,300 a month before taxes, without making any principal payments. With your $2,500 in Social Security this would be very generous $10,800 per monththough taxes can affect the bottom line.
The problem is volatility. A 10% rate of return is average. Some years the market is better, some years worse. Some years take active losses. You need to have the financial flexibility to make few, or even no, withdrawals during the down years or risk the sequence damaging your portfolio. Some retirees can do this, making the stocks they choose for most people in retirement.
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Annuity: “If retirees want the highest guaranteed income,” said Mark R. Hayes, CFP®, Founder of Infinitive Wealth Advisory to SmartAsset, “they can simply push their savings across the table to an insurance company instead of a SPIA, or a single premium direct annuity. Account this type acts like a traditional pension where the income will be paid until the death of the pensioner, although one of the main disadvantages is that the pensioner cannot control the nest egg.
Annuities can be amazing and, like bonds, effectively eliminate longevity risk. As Bryan M. Kuderna, CFP®, author of What should I do with my money?calculate, a $1 million annuity purchased at age 65 could pay $75,000 per year, or $6,250 per month. With your Social Security payments, this would be $8,750.
It is important to understand that this is a hypothesis. Other than the annuity option, it is rare (and not recommended) to hold all the money in one asset. The point is just to illustrate the kind of monthly income $1 million can generate.
Calculating Spending Needs for Retirement
The question is what looks “comfortable”, because this second part is the spending side. How much money do you need in retirement? Creating a budget is important because you need to know if your savings can meet your needs, and if your lifestyle can match your savings.
“As you retire, we encourage our clients to be honest about their spending,” Kuderna said. “Don’t discount your projected expenses, lifestyles don’t become cheap after a certain age. Running a fixed expense budget with additional miscellaneous buffers is critical. As I tell my clients, when I retire every Saturday, then miscellaneous expenses can higher than expected.
This last is a particular risk.
Many people plan for retirement with the assumption that the cost of living will decrease. They envision a more modest life, with fewer financial needs. To a certain extent that is true. You’re unlikely to have childcare or college expenses, for example, and you no longer need to budget for monthly contributions to your retirement account (although it should be replaced by a monthly savings budget).
But don’t make unrealistic assumptions. You will want to enjoy life, not stay indefinitely stuck to a hard budget drawn up at the age of 47. Among other expenses, honestly look at:
A financial advisor can help you map out your retirement and achieve your financial goals. Match with an advisor today.
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As in good budgeting, you should consider your portfolio and income potential for your needs and wants, and build a comfortable buffer for the unexpected. You have $1 million in an IRA and $2,500 in Social Security benefits. It’s enough money for retirement for some people, but make sure you plan what your needs are and how they fit into your budget.
IRA Investment Tips
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Building a $1 million IRA is quite an achievement. And the first step is understanding…what is an IRA in the first place?
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A financial advisor can help you create a comprehensive retirement plan. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three verified financial advisors serving your area, and you can have a free introductory call with your advisor to decide what’s right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
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Keep an emergency fund in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuations like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But high interest accounts allow you to earn compound interest. Compare savings accounts from these banks.
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