Your mid-fifties is a good time to do a retirement check.
To be clear, you should always have at least one eye on retirement. This isn’t something to ever forget entirely. But most of the time, that means nothing more than making sure your annual contributions go through in-full, on-time and to the right places, and that you take any appropriate tax breaks. Otherwise, the best thing you can usually do for your retirement account is to make a good plan and stick to it.
That said, there are a few important exceptions to that rule. One exception is when you speak with your financial advisor. After all, to maintain your retirement plan you need to make that plan in the first place. Another exception is when you periodically check in with yourself and your money. Every once in a while it’s important to check on your savings and make sure you don’t need to adjust your contributions, change the plan or otherwise make adjustments.
Age 55 is an excellent time for one such check. You have enough time to build real wealth and make adjustments, but at the same time your retirement is close enough to make the issue real. For example, let’s say you have $490,000 in a 401(k) and make $80,000 per year. What kind of retirement budget are you on track for?
Your retirement budget generally has three main components: Social Security income (fixed, taxed at a beneficial rate), Portfolio income (variable, with variable tax rates), and Spending (based on personal needs and lifestyle).
So, first estimate your Social Security income.
Your Social Security benefits will be based on the amount you earned during your working life. Specifically, the government gives you credits for your 35 highest-earning years, then calculates your benefits on those accumulated credits. So if you are still working, your Social Security benefits might increase if you earn more money in future years.
If Social Security makes up your base income, your portfolio will make up any additional income. Here, you have about 12 years left until full retirement age. Your income, then, will depend on the value of your portfolio at retirement age and how you choose to manage that money in retirement.
Here, let’s assume you make the standard 10% contributions to your portfolio each year, giving you $8,000 per year in additional funding. (We will assume away inflation for a simplified example.) If your portfolio generates a mixed-asset 8% rate of return, you might have about $1.4 million in your portfolio by age 67.
But that’s just one number, based on one set of assumptions. This can vary significantly based on your savings, your rate of return and many other variables. For example, say that you invest in a safer, more conservative bond-based portfolio that earns a 5% corporate bond rate of return. That might give you about $1 million at age 67. On the other hand, say that you invest entirely in higher-risk, growth-oriented S&P 500 index fund. That might give you about $1.9 million by age 67.
We will assume a middle ground approach, one that could give you about $1.4 million to retire on. The next question is how you structure the income you draw down from this portfolio.
Remember, these examples are simplified for illustrative purposes. Inflation, different rates of return and other considerations might impact your own numbers. Consider matching with a financial advisor if you need help running the math for projections based on your goals.
How you draw income from your retirement portfolio depends significantly on your approach to risk. Many sites phrase this as tolerance for risk, but this is misleading. This is about risk management. Your approach to risk should not be based on how much you are willing to roll the dice, but rather about your capacity to manage or adapt to losses if and when they occur.
If you are not simply willing to chance it, do not accept higher-risk assets. That’s a gamble, not a plan. If you know how you will adapt to losses or reduced portfolio income, go ahead and invest in higher-risk/higher-return assets.
For withdrawals, you might take a few different approaches. One is the traditional 4% withdrawal strategy, in which you plan to withdraw 4% of your portfolio each year for 25 years, with conservative investments that primarily offset inflation. In this case, you might expect for portfolio income of about $56,000 ($1.4 million * 0.04), combined with Social Security for a total income of about $98,406 per year.
Some financial advisors may suggest that this approach is unrealistically conservative in the current market however. Given that the average triple-a corporate bond has averaged around 5% interest rates in recent years, this may be true. Even if you moved your portfolio entirely into 5% interest bonds at retirement, that yield would generate $70,000 of annual interest payments alone without drawing down on the portfolio principal ($1.4 million * 0.05).
You could also invest for aggressive growth, taking a higher-risk/higher-reward approach to your retirement income. In this case you might leave your money in an S&P 500 fund. This would give you the market’s potential 11% average annual returns, but with exposure to the down years associated with equities. This approach might generate $154,000 in portfolio returns during average years, while accepting that some years could be significantly higher and others significantly lower. A large emergency fund may be appropriate in a high-risk case.
Or you might invest in a lifetime annuity. This product has the virtue of security, offering a guaranteed monthly income for life, with the downside of inflation exposure, since your payments will never increase over time. A representative annuity, if purchased at age 67 for $1.4 million, might pay you around $9,000 per month/$108,000 per year.
These are just a handful of examples. For the rest of the example, let’s take a middle-of-the-road option. Let’s assume you invest in bonds and withdraw 5% of your portfolio per year. This might give you a combined income of around $112,400 per year, and even that number is likely conservative if you invest in bonds paying 5% interest and draw down some of your portfolio’s principal as well as yield each year.
This is your budgetary starting point: around $112,400 per year.
The next question when making your retirement budget is, will that be enough? This depends entirely on your spending, needs and applicable taxes.
As a place to start, most financial advisors recommend the 80% rule of thumb. That is, in order to maintain your current standard of living, in retirement you should expect to spend about 80% of the income you needed during your working life. This is to account for the fact that your spending typically decreases in retirement, and you won’t need to set aside income for your retirement savings any longer.
So, you can start there. If you live on $140,500 or less ($112,400 / 0.8), then there’s a good chance that these numbers will meet your budget and match your needs. Given that you make $80,000 per year, you’re on track to potentially have more money in retirement than you do today, but remember that inflation will cause costs to be higher in the future. At a 2% rate of inflation over the next 12 years, $80,000 today could be worth the same as about $100,000 in the future.
Taxes are also going to cut into your gross income. While Social Security generally receives some tax break, your portfolio income will put you at the highest tier of Social Security taxes in this example, with 85% of your benefits being taxes. And if your retirement portfolio is in a 401(k) or other pre-tax account, you will also owe income taxes on your withdrawals. You can consider a Roth conversion at this point if you want to avoid such taxes in the future as well as required minimum distributions, which cause some level of inflexibility in your withdrawals.
You can start to run some numbers. The question here is, how will your spending match your income? The best way to figure that out is to analyze your monthly budget. How much do you spend each month? How much of that is nondiscretionary (housing, medicine, and bills for example) and how much of it is discretionary (entertainment and travel, for example)? Where can you make adjustments if you need to?
But again, the good news is that you have a lot of flexibility in this budget. Basic estimates suggest that you are likely to have a comfortable retirement income relative to your current income. So odds are that your game plan can be to just stay the course. Consider speaking with a financial advisor to make sure you’ve planned for the relevant retirement considerations based on your own personal goals.
Your mid-fifties is an excellent time to take stock of where you are in your retirement planning. With enough time left to boost your savings, make sure to look at your portfolio, your Social Security and your likely needs, then figure out if you’re on track to have the kind of budget you want to live on.
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The post What’s a Realistic Retirement Budget? I’m 55 With $490k Saved, Making $80,000 Annually. appeared first on SmartReads by SmartAsset.
