Retiring at age 62 and filing for Social Security will reduce a person’s lifetime benefits by as much as 30%, compared to waiting until full retirement age. However, someone with $2.5 million in a Roth IRA may feel more comfortable retiring at age 62, despite the impact early retirement will have on their Social Security.
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Can someone with $2.5 million in Roth IRA and who expects to collect about $2,500 in monthly Social Security checks afford to retire at age 62? The likely answer is yes, but there are some crucial things to consider if you find yourself in a similar financial situation.
Don’t overestimate your benefits
First and foremost, make sure you know for certain how much your Social Security benefits will be. Mike Dever, founder and CEO of Brandywine Asset Management, says someone who expects to collect $3,000 at age 62 has miscalculated his Social Security income.
While the full retirement age for someone retiring today is 67, the maximum amount someone can collect at age 62 is $2,572, Dever noted.
The $428 difference between $3,000 in monthly benefits and $2,572 is not itself essential. The majority of this retiree’s income will come from the $2.5 million Roth IRA. But the bigger issue is absolutely crucial: beware of miscalculations.
A person who expects to receive $3,000 in monthly benefits at age 62 would ultimately have $5,000 less in annual income. Double-check all your assumptions before you leave the job market because you don’t want to discover a mistake like this after the fact. A financial advisor can help you estimate and plan your Social Security benefits.
Prepare for inflation and volatility
With a Roth IRA balance of $2.5 million, a retiree can plan relatively generous withdrawals.
“The 4% withdrawal rule can be a useful starting point,” says Bryan Cannon, author of “Retirement Unplanned: An Expert Guide For Navigating The Crossroads of Retirement With Confidence.” Considering that both corporate and government bonds have an average interest rate of about 4%, “your Roth IRA would generate $100,000 in tax-free income annually during your retirement, typically without depleting your principal over time.”
“But,” he said, “it is essential to be careful when adhering to the 4% rule.”
Despite this well-funded retirement account, there are two major risks, but a financial advisor can help you prepare for both.
Consider the impact of inflation
First, as Dever noted, inflation is a hidden risk. Most investors learn the common wisdom of investing in growth-oriented assets during their working lives and in more conservative, income-oriented assets once they retire. This is a strategy built around protecting your savings during your retirement years.
The problem is that you won’t generate new growth. At best, your portfolio will keep pace with your withdrawals. It’s more likely that your withdrawals will modestly exceed your growth, while the value of that money steadily declines due to inflation.
“The problem with that kind of pension structure, where you depend on fixed income, is the inflation risk,” says Dever. “If inflation remains subdued as it has been until recently, that’s not a big problem… but the problem you have is that if inflation picks up at all, you’re just going to be swamped.”
“Your liabilities increase significantly while your assets are fixed.”
Dever and Cannon emphasized managing your investments in retirement. Look for more than the standard safety-oriented asset, because you’ll need growth that at least partially offsets both your withdrawal rate and long-term inflation.
Protect against market volatility
However, that brings with it the second risk. As you manage your portfolio into retirement, you also need to consider market volatility.
“Market volatility can lead to fluctuations in your income over time,” Cannon said. “For example, if you plan to withdraw 4% from a $2.5 million ($100,000) account, but your investments decline by 20% due to negative market returns, your 4% withdrawal would yield only $80,000.”
“If you structured your retirement lifestyle around withdrawing $100,000 a year, you would be forced to increase your withdrawal rate to 5%,” he added. And that can quickly lead to an irreversible cycle of depleting assets and driving withdrawals to compensate.
Dever and Cannon agreed that the way to manage this is to remain flexible with both your investments and your withdrawals. Build a smart portfolio that is looking for some growth, while retaining the ability to adjust your withdrawals as needed.
Expenses and lifestyle
This brings us to the last big question. What are you planning to do with your lifestyle?
Dutch Mendenhall, CEO of RAD Diversified REIT and author of “Money Shackles,” said this is “the ultimate factor in determining how much money you should save for a comfortable retirement.”
“The richer and grander you decide to go will ultimately cost more than a simple, easy retirement, putting you at risk of outliving your savings and not being able to cover the costs with just a Social Security check.”
As we noted above, depending on how you manage your investments, you can probably expect an income of about $100,000 per year plus another $30,000 per year in Social Security. Under normal circumstances that should take you into the early 90s, possibly longer. If you need more help planning a retirement budget or creating an income plan, consider speaking to a financial advisor.
So there are two lifestyle issues to consider. First, does your lifestyle fit into a $130,000 per year budget? If your post-retirement lifestyle exceeds this spending limit, what changes can you make to achieve that goal? Or are you comfortable waiting another five years to get more Social Security and grow your IRA even more?
Second, what flexibility does your lifestyle have? “Think about your travel plans, housing costs, possible moves or events you want to see in your life,” Mendenhall said. “These factors will help you determine where to cut back in specific areas of life to make these dreams possible.”
When your lifestyle is more flexible, you have more room to invest in growth and deal with unexpected expenses. It may not be fun to skip your annual trip or skimp on other luxuries, but if your annual budget needs to drop to $110,000, you can do so.
Create a plan for your expenses and work backwards. Once you know how much money you need and how much you want, you can get a good idea of whether you have enough money to retire.
In short
A $2.5 million Roth IRA and Social Security benefit of $2,572 per month will put someone in a strong position to retire at age 62. Their investments and monthly benefit checks will provide about $130,000 in the first year of retirement, which should be sufficient depending on their lifestyle. Ultimately, it depends on a retiree’s lifestyle expectations and how much they plan to spend on a regular basis.
Tips for retirement spending
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Part of planning your retirement expenses is estimating how much less you need. Research has shown that a person’s wealth and health are two key factors in the extent to which their expenses decline in retirement.
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A financial advisor can help you draw up a comprehensive retirement plan. 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 a free introductory meeting 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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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.
Photo credit: ©iStock.com/FG Trade, ©iStock.com/Luke Chan, ©iStock.com/AzmanJaka
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