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As you budget for retirement, it’s important to keep two questions in mind. First, understand your needs — what budget will you need to pay the bills and what budget do you want to afford for your lifestyle? And second, understand your capacity — what income can your portfolio comfortably and reliably generate for you?
Your retirement budget will lie at the intersection of these numbers, where your capacity meets your needs. In this case, let’s assume you have a household of two. As the question states, you have $4,500 a month in Social Security benefits and a $1.5 million IRA balance. Here are a few things to consider as you prepare to build this retirement budget.
First of all, determine your personal and financial goals for retirement.
For example, between returns and security, consider what you will prioritize when it comes to your finances. Do you want to retire immediately at the age of 63 or will you wait until the age of 67? Will you keep your current lifestyle and location or will you look for a change or a cheaper/more expensive area? Do you plan to continue working and when will you start receiving Social Security? Do you have any specific estate planning goals?
This may seem like a wall of questions, but all of these factors will determine how you manage your money during retirement. Being very intentional about your choices can allow you to grow your money as you go through retirement. (And if you need help creating a retirement plan, talk to a financial advisor.)
Once you have a sense of your goals, it’s time to think about your spending. A good rule of thumb is that most households need about 80% of their pre-retirement budget to meet their post-retirement needs. In addition, some critical issues to consider include the following.
If you own your home, be sure to set aside money for taxes, insurance, and maintenance. If you are renting out your home, the annual rent budget increases. These typically exceed core inflation, and sometimes a lot, depending on where you live. After all, rent is expensive, but so is a new roof.
How expensive is your hometown? Retiring to Michigan’s Upper Peninsula will cost a lot less than living in San Francisco or Boston. You should also expect prices to rise faster in an expensive city, a concept known as the “personal inflation rate.”
Do you want to travel, attend concerts or spoil your grandchildren? Do you enjoy gardening, cooking or working on cars? Whatever your personal hobbies are, factor them into your budget. A good way to calculate this is to start with your current spending on entertainment and hobbies and change from there.
While most of your budget will shrink in retirement, your health care needs will almost certainly grow. Value both long-term care insurance plans and Medicare gap coverage plans, since you may want both forms of coverage. Additionally, talk to your doctor so you can start planning sensibly for future healthcare costs.
General spending includes almost all consumer goods, from a new iPhone to grocery shopping. This “other” category makes up a significant portion of your monthly expenses, and you don’t want a budget that pays the rent but leaves no room for these basics.
The final step is to decide how you will manage your income and remaining assets over time. Here we have a household of two with Social Security benefits and an IRA balance. Your Social Security income alone should cover most of your needs. At $4,500 a month ($54,000 a year) for each of you, those benefits could cover the needs of many retired couples.
From there, let’s look at your IRA.
One of the first questions for a household preparing for retirement is how to deal with debt. At age 63, you can withdraw money from your IRA without tax penalties, although you will still owe taxes. As a result, you may want to consider taking out a lump sum to cover remaining mortgage, car, education or other forms of significant debt. This will reduce your household’s fixed overheads and unproductive interest payments, but at the cost of paying off some investments.
There is also the issue of long-term withdrawal. You have $1.5 million invested in a traditional IRA before taxes. At a 4% withdrawal strategy, meaning you target safe 4% growth and withdraw 4% per year, this account could generate about $60,000 per year in inflation-adjusted income over 25 years. Together with your Social Security, that will give you about $114,000 a year or $9,500 a month.
However, these numbers can change depending on your investment strategy decisions.
For example, you could buy a lifetime annuity with your $1.5 million IRA, which could generate similar or higher guaranteed payments, depending on the options you’re looking for. However, this type of annuity income is fixed, so you’ll need a plan to prevent your spending power from declining over time.
You could also invest for more aggressive growth. This may include building a mixed portfolio, searching average returns of around 8%, or invest in an S&P 500 index fund, looking for average returns of around 10% based on historical averages. Both of these approaches can increase your potential withdrawals, but both come with occasional losses and years of decline.
Finally, don’t forget to anticipate taxes. You will owe income tax on your IRA withdrawals. You will also almost certainly owe tax on a percentage of your welfare benefits as your income will likely exceed the income thresholds set by the IRS. Again, be sure to factor this into your budget.
AND financial advisor can help you create a comprehensive retirement plan. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three trusted financial advisors serving your area, and you can have a free introductory conversation with your advisors 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.
Budgeting in retirement can seem like a lot of guesswork. After all, it’s hard enough to plan for your needs and wants today, let alone a hypothetical version of yourself decades from now. But it is still important to try to correct this, and the good news is that this is easier than it might seem.
Keep an emergency fund handy in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to significant fluctuations like the stock market. The trade-off is that the value of current money can be reduced by inflation. But a high interest account allows you to earn compound interest. Compare the savings accounts of these banks.
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