It’s probably possible for most people to retire at age 55 if they have $2.5 million in savings. However, the final answer will depend on the interplay between several factors. These include your health, your expected retirement lifestyle and expenses, and how you invest your savings. Some factors, such as lifestyle choice or investment strategy, are predictable or controllable. This is less the case with others, such as health and life expectancy.
A financial advisor can help you devise a workable retirement strategy.
Is retirement at age 55 possible with $2.5 million?
Retiring at age 55 with $2.5 million is certainly feasible, as evidenced by the fact that this is far more than the vast majority of people who retire. According to the Federal Reserve’s Survey of Consumer Finances, only about 1 in 10 retirees has saved even $1 million. If more than 90 percent of people can retire with much less than $2.5 million, that’s probably enough for you.
A $2.5 million nest egg could generate $100,000 in income per year if you tap your accounts at the oft-cited 4% sustainable withdrawal rate. This rule predicts that if you withdraw that percentage from your accounts every year, a savings pot will last at least 30 years.
Will your income be sufficient?
An annual income of $100,000 is well above the average salary of $60,944 earned by people aged 55 to 64 who are still working. And many retirement planners suggest using 70% of pre-retirement income as a starting point when budgeting for post-retirement expenses. Seventy percent of $60,944 is $42,661. With that in mind, $100,000 per year is probably more than enough income for the average single retiree or even a married couple. Even if we assume the 90% income replacement figure, which is at the high end of the range used by retirement planners, $100,000 isn’t far off.
Using the safe withdrawal rate is not the only strategy. Retirees can generate income by investing in fixed income securities, dividend stocks and annuities. These income-oriented investment strategies, individually or in combination, can potentially return 4% or more per year. If successful, this approach allows a retiree to continue their lifestyle without withdrawing from their core job, potentially allowing it to continue indefinitely and leave a financial legacy to heirs or charitable causes.
If you’re ready to be matched with local advisors who can help you achieve your financial goals, start now.
Accounting for taxes
Taxes represent a difficult to predict factor whose importance varies mainly depending on location and source of income. For example, eight states have no income tax and seven other states do not tax retirement income.
The largest state by population, California, taxes retirees’ income, including withdrawals from retirement accounts, as regular income. The SmartAsset calculator for California retiree taxes indicates that a single person born in 1968 will pay $5,520 in state income taxes on $100,000 of California taxable income.
Federal income taxes may take a different portion depending on the source of the income. For example, withdrawals from a Roth IRA generally are not subject to federal income taxes. Investment income and withdrawals from any type of retirement account do not incur payroll taxes. However, withdrawals and investment income of $100,000 may be subject to a long-term capital gains tax of 15% or $15,000.
In this simplified hypothetical example, the combined effect of state and federal taxes on a California retiree with $100,000 in retirement income would leave $79,480 in after-tax income. Deductions and credits would likely adjust after-tax income upward for most retirees. The unadjusted remainder is well above the standard 70% replacement income for a single retiree, but can be significantly lower than the needs of a married couple.
What can go wrong?
Healthcare costs represent a factor that is difficult to quantify in advance and could potentially change these results. A study by the Employee Benefits Research Institute found that it would cost a 65-year-old couple with typical prescription drug costs $318,000 in savings to be 90 percent confident of covering their health care costs in retirement.
If you set aside $338,000 of $2.5 million to cover health care costs, the remaining $2.182 million will allow for a safe withdrawal amount of just $87,280 before taxes. And this hypothetical example does not include health care costs from ages 55 to 65. Since Medicare coverage does not become available until age 65, paying for health care costs for a decade using private health insurance or other means could significantly increase the number of out-of-benefit benefits. pocket costs above that level.
Rules for withdrawing tax benefits from retirement accounts can also pose a problem. Until age 59.5, withdrawals from most types of accounts will, for most people, include not only any income tax liability but also an additional 10% penalty. This would reduce the purchasing power of your withdrawals until you reach cut-off age.
Inflation, another potential problem, reduces the purchasing power of a retiree’s income. For example, if inflation reaches the 2% level that Federal Reserve policymakers are aiming for, this would reduce purchasing power from $100,000 in the first year to $98,000, $96,040 in the second year, and so on.
However, this hypothetical inflation example does not take all factors into account. For example, interest rates often rise when inflation rises. That could result in income from a portfolio of interest-bearing investments rising about as quickly as inflation reduces purchasing power.
Finally, age 62 is the youngest age at which most people are eligible to receive Social Security benefits. Social Security benefits, which average $1,827 per month in 2023, can go a long way toward paying for living expenses in retirement. The need to wait for the security of those monthly Social Security checks is probably one of the biggest reasons why more people don’t retire at age 55.
In short
A retirement account worth $2.5 million will likely fund a secure retirement for most retirees. Whether it will work for you depends on how much you plan to spend in retirement, what type of investment strategy you choose and some important, less controllable factors, including future healthcare costs and overall life expectancy. But since this is far more than most people retire at any age, having $2.5 million in savings is a strong indicator that you can retire confidently at age 55.
Retirement planning tips
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The combination of uncertainty about the future and a wide range of possible strategies can make it difficult to effectively plan for retirement without the help of a financial advisor. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors for free to decide which one 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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Even if you don’t know exactly what will happen between now and retirement, SmartAsset’s retirement calculator can help you make a reasonable forecast. To use it, enter your information including location, income, age at which you plan to start receiving Social Security benefits, current monthly savings amount, and other information. The calculator tells you how much income you are likely to need in retirement, how much Social Security will contribute, and how much you should have saved by the time you stop working.
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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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