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I am 55 and looking to retire now, with total net worth of $3 million. I assume my net worth will grow at an average rate of 5% until I qualify for Social Security. My house is paid off and my lifestyle is simple. I can live on $5,000 a month. Am I making the right decisions?
– Peter
At first glance, paying $5,000 in monthly living expenses on $3 million seems like an easy task. But I like to start by thinking about these types of scenarios in terms of your distribution rate: the percentage of your money you withdraw each year. Withdrawing $60,000 per year would equate to an annual withdrawal rate of just 2%, which is incredibly low for just about anyone. This means you run little risk of running out of money.
However, since you say “net worth” instead of savings or savings, I would encourage you to take a close look at how your assets are made up. Are your assets largely liquid, such as stocks and cash? Or is your net worth mainly in illiquid assets, such as real estate? The answer may determine how much you can afford to withdraw. (And if you need more help determining when to retire, consider talking to a financial advisor.)
Your net worth is the value of all your assets minus any debts. For example, if you own a property worth €500,000 and have a mortgage of €300,000, this will contribute €200,000 to your net worth. Of course, your investments, cash and other savings all contribute to your net worth as well.
I mention this because the way your $3 million net worth is divided among different types of assets can affect how well you are able to support yourself. Not all assets offer the same level of flexibility.
To illustrate my point, consider this hypothetical scenario: Your house, which you own free and clear, has a current market value of $2 million. This means that your liquid assets are worth a maximum of €1 million. Assuming you don’t want to tap your home equity, you would use your $1 million in liquid assets to cover your monthly living expenses. That means you would be withdrawing 6% of your portfolio per year, which is significantly higher than the 2% previously mentioned, putting you at greater risk of running out of money.
If illiquid assets are only a small part of your total net worth, this isn’t much of a problem. Be sure to consider this balance when determining a benefit rate and developing a retirement income plan. (A financial advisor can help you assess your assets and create a retirement income plan.)
If you rely on distributions from tax-advantaged retirement accounts, pay attention to the rules for early distribution. Because you are not yet 59.5 years old, in most cases you will have to pay a 10% fine.
However, there are notable ways to get around this rule. If you have an IRA, consider making substantially equal periodic payments (SEPPs), which can tap into your savings before age 59½ without incurring the early distribution penalty. Please note that once you start SEPPs, they will continue on an annual basis for five years or until you reach age 59.5. If you cancel these payments before then, you will be charged a 10% penalty.
If you have a 401(k), the Rule of 55 can also help you access your retirement savings early. This rule allows you to withdraw money from your current employer’s 401(k) or 403b plan without penalty if you leave that job in the calendar year in which you turn age 55 or later. (And as you decide how best to withdraw your retirement savings, SmartAsset’s free tool can help match you with a financial advisor.)
Your own personal preferences regarding lifestyle, investments and risk tolerance also play a role in this planning. It is very important that you do not overlook this. What works for someone else may not work for you.
For example, if you are particularly risk averse, you may invest too conservatively and your portfolio may not grow enough to support inflation-adjusted withdrawals. You should also be sure that you have taken inflation into account in your growth estimate.
On the other hand, if you are a very aggressive investor (although it doesn’t sound like it) and invest too heavily in stocks, you may become overexposed to the cascade of return risks, which can also derail you.
Again, I’m using extremes. There is a wide range between these points that works fine. I’m simply illustrating the point where you should consider how your personal attitude toward different facets of your financial plan should influence your decision. (A financial advisor can help you take your lifestyle and other personal preferences into account when planning for retirement.)
Most people will be able to support a monthly retirement budget of $5,000 with $3 million, as long as it is sufficiently liquid and well diversified. However, the math is never the full story. Be sure to consider how personal factors, such as your risk tolerance and lifestyle expectations, may impact your financial plan in retirement.
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Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have free introductory calls with your advisors to decide which one you think 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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Consider a few advisors before choosing one. It’s important to make sure you find someone you trust to manage your money. As you consider your options, these are the questions you should ask an advisor to ensure you make the right choice.
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Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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Brandon Renfro, CFP®, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor an employee of SmartAsset, and has received compensation for this article.
Photo credits: ©iStock.com/visualspace, ©iStock.com/praetorianphoto
The post Ask an Advisor: I’m 55, with a net worth of $3 million and $5,000 in monthly expenses. Can I retire now? first appeared on SmartReads by SmartAsset.
