A recent New York Times article discussed that a $1 million retirement nest egg isn’t what it used to be. While this is more than 90% of U.S. retirees have amassed, $1 million doesn’t go as far as you might think. That said I wanted to take a look at what it takes to provide $100,000 income annually during retirement.
The 4% rule
The 4% rule says that a retiree can safely withdraw 4% of their nest egg during retirement and assume that their money will last 30 years. This very useful rule of thumb was developed by fee-only financial planning superstar Bill Bengen, a NAPFA colleague.
Like any rule of thumb it is just that, an estimating tool. At you own peril do not depend on this rule, do a real financial plan for your retirement.
Using the 4% rule as a quick estimating tool let’s see how someone with a $1 million combined in their 401(k) s and some IRAs can hit $100,000 (gross before any taxes are paid).
Doing the math
The $1 million in the 401(k)s and IRAs will yield $40,000 per year using the 4% rule. This leaves a shortfall of $60,000 per year.
A husband and wife who both worked might have Social Security payments due them starting at say a combined $40,000 per year.
The shortfall is now down to $20,000
|
Source of funds |
Annual income |
|
Retirement account withdrawals |
$40,000 |
|
Social Security |
$40,000 |
|
Need |
$100,000 |
|
Shortfall |
$20,000 |
Closing the income gap
In our hypothetical situation the couple has a $20,000 per year gap between what their retirement accounts and Social Security can be expected to provide. Here are some ways this gap can be closed:
- If they have significant assets outside of their retirement accounts these funds can be tapped.
- Perhaps they have one or more pensions in which they have a vested benefit.
- They may have stock options or restricted stock units that can be converted to cash from their employers.
- This might be a good time to look at downsizing their home and applying any excess cash from the transaction to their retirement.
- If they were business owners they might realize some value from the sale of the business as they retire.
- If realistic perhaps retirement can be delayed for several years. This allows the couple to not only accumulate a bit more for retirement but it also delays the need to tap into their retirement accounts and builds up their Social Security benefit a bit longer.
- It might be feasible to work full or part-time during the early years of retirement. Depending upon one’s expertise there may be consulting opportunities related to your former employment field or perhaps you can start a business based upon an interest or a hobby.
Things to beware of in trying to boost your nest egg
- Avoid high cost financial products that often do more to boost the bottom line of the financial sales person than that of their clients.
- Likewise don’t give into the fear mongers peddling financial products like Equity Index Annuities or similar products “that can’t lose.”
- Don’t be too cautious with your investments in retirement, inflation is a retiree’s worst enemy.
- On the flip side don’t take on excessive investment risk in an effort to catch up if you feel that you are behind where you need to be.
The scenario outlined above is hypothetical but very common. As far as retirement goes I think financial journalist and author Jon Chevreau has the right idea: Forget Retirement Seek Financial Independence.
Please feel free to contact me with your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.
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