Social Security is often a key source of income for many retirees when determining their ideal retirement budget.
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A retirement budget has two major parts: income and expenses. Income can come from many sources, including Social Security or pension retirement benefits, annuity payments, investment interest and retirement account withdrawals. Expenses are the money you spend those funds on, such as housing, transportation, utilities, food and healthcare. Since budgeting involves forecasting, precision can be difficult. As a result, retirement budgeters often rely on rules of thumb, like the 4% safe rate for withdrawals and the 80% of pre-retirement income budget. Much depends on details, but with $1.1 million in tax-deferred retirement accounts and the expectation of $2,800 in Social Security benefits, you can probably craft a comfortable and financially secure retirement. And a step-by-step process can help you generate useful estimates.
A financial advisor can also help you put together a retirement budget.
Here’s a method you can follow to quickly frame out your retirement budget.
Your retirement lifestyle expectations play a major role in determining your retirement budget. Now is the time to think about your plans for using the extra time after you stop working, as well as the possible financial impacts of these plans.
For instance, will you spend more time with family? Are they nearby or will visits involve costly long-distance travel? Will you engage in hobbies and, if so, what kind? Obviously, a sailboat hobby will affect your budget more than attending local square dances. How much will you travel and where? A camping excursion to domestic historical sites will be more easily affordable than a first-class tour of European capitals. And so on. Planning for how you’ll spend your time will inform your budget process.
The 80% guideline provides a quick way to rough out your likely retirement expenses. To use it, multiply your salary the last year you worked by 80%. On average, the result will approximate the amount you’ll spend after you retire. For instance, if you make $100,000 your last year working, you can probably expect to need about $80,000 to pay your bills after retiring.
Over time, studies of retiree finances have shown this guideline reflects many retirees’ experiences. However, the actual percentage may vary from 55% to 90%. Your own experience is also likely to differ somewhat based on your lifestyle and needs. But this exercise will probably get you close.
Another way to estimate retirement expenses is to look at your current expenses and subtract those you don’t expect to have after retiring. Chief among these are work-related costs, like commuting, clothing and meals away from home. Also, naturally, retirement savings generally stop after you retire. You’ll also likely spend less on education and taxes, although your healthcare costs typically rise.
Turning to income, Social Security is an important part of retirement finance for most retirees. Your $2,800 monthly benefit will increase annually due to a cost-of-living adjustment pegged to inflation, protecting your dollars’ purchasing power. Social Security payments continue for your life and can support your survivors after you are gone.
The 4% guideline is often used in retirement planning to set a safe amount you can pull from retirement savings each year. To use it, multiply your account balance by 4%. For instance, $1.1 million in combined IRA and 401(k) accounts would permit $44,000 in safe withdrawals the first year. In subsequent years, the amount increases by the inflation rate. If inflation the first year was 3%, you’d withdraw $45,320 the second year, and so on. Computer models indicate a very high likelihood that a conservatively invested portfolio evenly balanced between stocks and bonds will last at least 30 years without running out of savings using this method. A financial advisor can help you build a portfolio with the longevity and asset allocation to support this goal.
Instead of investing in the market, you could purchase an annuity. Annuities provide guaranteed annual income, regardless of market fluctuations. There are many annuity types, but a simple annuity might give you an annual payment equal to 7% of the purchase amount. A $1.1 million annuity would, in this example, produce $77,000. While that’s more than a safe withdrawal from an investment portfolio, annuities don’t usually include cost of living adjustments. Perhaps more importantly, annuity payments may not continue after your death, leaving survivors to fend for themselves.
Retirees often blend these income methods, along with others such as investing in dividend-paying stocks, to craft an income stream that provides flexibility to meet changing conditions. The amount and reliability of the resulting income can vary widely. Assuming you stick to a conservative investment style, you can likely generate total retirement income of $77,600, including $33,600 from Social Security and $44,000 from investments.
Budgeting well often involves more complexity than in this simple example. Here are some other things to consider:
Life expectancy. How long you’ll live may be the single most important retirement planning issue. After all, about 1 in 6 American men do not live to age 65, and if you die before retiring, the entire exercise is arguably moot. The number of years you will spend retired also figures in when estimating how much savings you need. Social Security estimates a typical 65-year-old man will live another 18 years. Women can expect another 21 years.
Taxes. Most retirees pay fewer income taxes after they stop working, but there are strategies for tax reduction that make taxes even less of an issue. For instance, while annuity payments and withdrawals from tax-deferred accounts such as IRAs and 401(k)s are taxable, you can reduce your taxable income by saving in a Roth IRA, which allows tax-free withdrawals. You may be able to convert IRA and 401(k) funds to a Roth, as well.
Inflation. Rising prices erode the purchasing power of your income in retirement. Social Security payments increase to account for this, and you can also mitigate inflation’s impact by increasing withdrawals from retirement accounts using the 4% guideline.
Required Minimum Distributions (RMDs). Once you reach age 73, you’ll have to start withdrawing from tax-deferred retirement accounts according to a schedule set by the IRS. Most retirees already withdraw more than the RMD amount, so this is not an issue for them. However, if you want to avoid RMDs you can do so by saving in a Roth account, which is not subject to RMD rules.
Long-term care. Many retirees eventually need some form of long-term care. Depending on the type and length of care, this can be a small amount, or more than you can easily pay. You can also consider long-term care insurance to hedge this risk.
Delaying retirement. Working longer is one of the most powerful ways to improve your retirement finances. Your Social Security benefit will increase by about 8% every year you wait to claim it, until you reach age 70. Similarly, the longer you let your retirement accounts grow tax-free before beginning withdrawals, the larger your safe withdrawal amount. Consider consulting with a financial advisor to weigh your options.
Review. Regularly pull out your retirement budget and see where it needs to be updated or adjusted. Variations in inflation, investment returns, healthcare costs and other factors may mean you need to make changes in how you spend or where you get your income.
With $1.1 million in tax-deferred retirement savings accounts and $2,800 from Social Security, you can likely expect $77,000 in income the first year if you retire immediately. Using the 4% withdrawal guideline and relying on Social Security’s cost-of-living adjustment, you’ll be protected against inflation and be unlikely to run out of money in your lifetime. Whether this will be enough to pay your expenses depends on your lifestyle expectations.
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost 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.
Where you retire can be one of the most important factors deciding how financially comfortable you’ll be. Use SmartAsset’s Cost of Living Calculator to see the sometimes-surprising differences in costs in different cities.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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The post I’m 65 With $1.1 Million in My 401(k) and IRA and a $2,800 Social Security Check. What’s My Retirement Budget? appeared first on SmartReads by SmartAsset.
