When you get to your first million dollars in investment assets, you should congratulate yourself on reaching a milestone. It may seem like you should never have to worry about money again. However, before you turn in your retirement notice, figure out what having $1 million really means.
To be secure in retirement and to account for the ups and downs of market conditions, you should consider withdrawing only 3 percent to 4 percent of your account value each year. Some studies indicate a 4 percent withdrawal rate may be safe; others suggest a lower rate is more prudent. To ensure you won’t run out of money, taking $30,000 to $40,000 per year from a $1 million portfolio should be your target. This amount can increase for inflation each year.
The portfolio withdrawal amount, on top of your other expected income, such as Social Security, is how much you can spend annually. Depending in your lifestyle, you may be surprised to find out you need significantly more than that amount before you retire. Consider what you spend now, while you are still working, and whether your expenses will increase or decrease in retirement. Do you plan to buy a second home or travel extensively during the next 10 to 15 years?
There are some unknowns in your future. You don’t know how long you will live, how healthy you will be, and whether your parents or children will need financial assistance. Having more than you think you need may protect you from expensive surprises.
If you retire before you are 65 and Medicare eligible, you will need to bridge the gap for health care insurance. Once you reach 65, Medicare premiums and a supplemental policy add to your costs. And there are health-care expenses that Medicare and/or a supplemental policy don’t cover.
Potential long-term care costs, if they’re not covered by insurance, could wipe out retirement assets needed by a spouse. Covering these potential outcomes through insurance can protect against this risk, but the premiums will increase your annual expenses.
And inflation is a fact of life. Your purchasing power could be cut in half over 20 years without a corresponding increase in income. Social Security may increase slightly each year, but health-care costs are increasing at a much faster rate.
Your total withdrawals from a portfolio need to cover investment management fees and taxes before you get to spend the difference. If a substantial amount of your retirement savings are held in tax-deferred accounts, like 401(k)s and IRAs, your federal and state income tax liability may be quite large. If you end up in a combined 35 percent tax bracket, for every $10,000 you withdraw, you will owe $3,500 in taxes before you get to spend the remaining $6,500. Some retirees are moving out of higher income tax states to keep a larger chunk of their budget to spend on other things.
Let’s look at a hypothetical. Bill and Jamie are considering retiring next year after inheriting $500,000 from her parents. Combined with their retirement assets of $500,000, they now have $1 million. They are both 62 and together net about $150,000 in salary after taxes and other payroll deductions. They would like to maintain that level of spending in retirement.
If they can count on their retirement assets generating $30,000 to $35,000 and $45,000 from Social Security at age 70, they still have quite a shortfall to be able spend $150,000 each year. They may need $3 million in savings to generate $105,000 to add to their Social Security to make ends meet. And they need to figure out how to make up the $45,000 shortfall between 62 and 70.
Many retirees have accumulated a large amount of wealth in their homes. Your home doesn’t produce income, however, and won’t help you make up a shortfall in retirement assets. For most homeowners, a home continues to be a significant part of the budget through repairs, property taxes and potential remodeling costs. If you are willing to sell your home and relocate to a much less expensive home, this could help make up a shortfall. But borrowing against your home equity will only increase your monthly expenses.
A million dollars does not go as far as you think. Understand your lifestyle and what your portfolio realistically can do for you before you retire.
This commentary originally appeared May 4 on TheCasperStarTribune.com
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