Do you have enough money to retire?
There are many different ways to look at this, but the most common is to simply break it down: money in versus money out. How much income can you generate with your retirement planning and how much do you need to spend?
Here, suppose you have $1 million in a 401(k) or IRA, and expect to receive $2,500 per month in Social Security benefits, a number right in the middle of the possible benefits. Can you retire at 65?
Well, it certainly depends on your standard of living. But for most people the answer is yes. This should be enough to generate a comfortable income in most parts of the country. Here’s how to think about it. (And if you need help planning your own retirement, consider consulting a financial advisor.)
Calculation of income needs at retirement
The first point here is income. How much money can you expect from your combined savings and Social Security? How much money will a million dollars in a pre-tax account generate, since we already have an idea of Social Security income?
The exact answer depends on how you manage your money in retirement. To understand that, let’s look at four possible investment options: cash, bonds, stocks and annuities.
But first we need to consider the all-important issue of longevity risk.
Longevity risk
As The Hill recently noted, most people underestimate how long they will live and therefore how long their retirement will last. In fact, most people expect the average American to live between 75 and 80 years, when life expectancy is actually 82 years for a man and 85 years for a woman.
The bottom line is that you want to make sure your money lasts at least as long as you live, and most people tend to underestimate that number. So if you retire at age 65, plan for at least 30 years of retirement. Preferably longer, if possible. After all, you want your 100th birthday to be good news.
Portfolio Considerations
You should also take into account the savings and investment vehicles in which your portfolio is held, as this will affect your returns and therefore your income during your retirement. Talk to a financial advisor to create a portfolio that meets your specific needs.
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Cash: Holding your money in cash means keeping all of it in deposit accounts or similar products, such as a savings account or certificate of deposit. There are a lot of problems here, but the biggest one is that even at the Federal Reserve’s 2% interest rate, these accounts tend to underperform inflation. This means that over time you will lose your purchasing power.
With cash, and assuming a 30 year retirement, you can expect to retire approximately $2,700 per month. ($1 million / 30 years = $33,333 / 12 months = $2,777) With your $2,500 in Social Security, this would give you about $5,200 per month to live on. In most parts of the country, this is a fairly comfortable income, although it also comes with a hard end date. From the age of 96 you must live solely on social security.
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Bonds: Bonds are often the preferred option for retirees. They generate modest returns and are about as safe as you can get without a deposit account. They also generate interest-based returns, meaning that if you invest enough in bonds, you can live off the returns alone without having to draw on your principal. While this will result in a higher tax rate than selling assets for capital gains, it also provides a significant degree of certainty. If you can live off the proceeds from your bonds, you can keep this account indefinitely.
At the current government interest rate of 4.3%, a $1 million portfolio would earn about $43,000 per year, or about $43,000 per year. $3,500 per month. With your Social Security benefits, that would give you about $6,000, again enough to live comfortably in most places. You could supplement this by drawing on principal, calculating a steady withdrawal rate, and you would have to factor in buying new assets as your bonds matured, but otherwise this is a source of income that is largely isolated from the longevity risk.
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Shares: The S&P 500 has a historical return of about 10% per year. For someone who owns $1 million in assets, a simple index fund would theoretically return about $100,000 per year. On paper, this means you can generate $100,000 per year, or $8,300 per month before taxes, without ever having to dip into principal. With your $2,500 in Social Security, this would be very generous $10,800 per monthalthough taxes can affect your bottom line.
The problem is volatility. That 10% return is an average. Some years the market does much better, other years much worse. Some years it takes active losses. You would need to have the financial flexibility to make few or even no withdrawals during bad years, otherwise sequence risk would cripple your portfolio. Few retirees can do this, making stocks a poor choice for most people in retirement.
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Annuities: “If a retiree wanted the highest possible guaranteed income,” Mark R. Hayes, CFP®, founder of Infinitive Wealth Advisory, told SmartAsset, “she could simply roll her savings to an insurance company in exchange for a SPIA, or a single loan . direct annuity premium. This type of account works like a traditional pension where income is paid out until the retiree’s death, although one of the main disadvantages is that the retiree loses any control over his/her savings.”
Annuities can be surprisingly lucrative and, like bonds, effectively eliminate longevity risk. As Bryan M. Kuderna, CFP®, author of What should I do with my money?calculates, a $1 million annuity purchased at age 65 could earn you $75,000 annually, or $6,250 per month. With your Social Security payments, this would be $8,750.
It is important to understand that these are hypotheses. Aside from the annuity option, it is rare (and inadvisable) to keep all your money in one asset. The point is simply to illustrate what kind of monthly income $1 million can generate.
Calculate your retirement spending needs
The question is what “comfortable” looks like, because the second part of this is the expense side. How much money do you need when you retire? Creating this budget is essential because you need to know if your savings can meet your needs and if your lifestyle fits your savings.
“In the run-up to retirement, we encourage customers to take an honest look at their expenses,” Kuderna continues. “Don’t cut back on your expected expenses, the lifestyle doesn’t magically get cheaper after a certain age. Running a fixed expenditure budget with an additional diverse buffer is crucial. As I often say to my clients, every day is Saturday when you retire, so various costs may be higher than expected.”
The latter is a special risk.
Many people plan for retirement under the assumption that their living costs will simply drop. They imagine a more modest life, a life with fewer financial needs. To some extent that is true. For example, you’re unlikely to have childcare or college costs, and you no longer need to budget for monthly contributions to your retirement accounts (although that should be replaced with a monthly savings budget).
But don’t make unrealistic assumptions. You want to enjoy your life and not be stuck indefinitely with a tight budget you set at age 47. Take an honest look at:
A financial advisor can help you map out your retirement and achieve your financial goals. Match with an advisor today.
In short
Like any good budgeting, you need to weigh your portfolio and income potential against your needs and wants, and build in a comfortable cushion for the unexpected. You have $1 million in an IRA and $2,500 in Social Security benefits. That’s enough money for some people to retire, but make sure you plan what your needs will be and how that fits into your budget.
IRA investment tips
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Building a $1 million IRA is quite an achievement. And the first step is to understand…what the heck is an IRA anyway?
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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.
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