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I am 55 years old and would like to retire now with a total net worth of $3 million. I assume my net worth will grow, on average, 5% until I qualify for Social Security. My house is profitable and my lifestyle is simple. I can live on $5,000 a month. Am I making the right decisions?
– Peter
At first glance, supporting $5,000 in monthly living expenses with $3 million seems like an easy feat. But I like to start by thinking about scenarios like this in terms of yours distribution rate – the percentage of your money that you will withdraw each year. Withdrawing $60,000 a year would equate to an annual withdrawal rate of just 2%, which is incredibly low by anyone’s standards. This would expose you to very little risk of running out of money.
However, since you say “net worth” instead of savings or savings, I would encourage you to take a hard look at how your net worth is made up. Are your assets mostly liquid, like stocks and cash? Or is your net worth primarily tied to illiquid assets, such as real estate? The answer may dictate how much you can afford to withdraw. (And if you need more help figuring out when you can retire, consider talking to a financial advisor.)
Your net worth is the value of all your assets minus all debts. For example, if you own a property worth $500,000 and have $300,000 mortgagecontributes $200,000 to your net worth. Of course, your investments, cash, and other savings also contribute to your net worth.
I mention this because the way your $3 million net worth is spread across different types of assets can affect how well you can support yourself with it. Not all funds provide the same level of flexibility.
To illustrate my point, consider this hypothetical scenario: Your house, which you own free and clear, has a current market value of $2 million. This means that your liquid assets are worth a million dollars at most. Assuming you don’t want to tap into your equity, you’d use your $1 million in liquid assets to cover your monthly living expenses. This means you would be withdrawing 6% of your portfolio annually, which is significantly higher than the aforementioned 2%, putting you at increased risk of running out of money.
If illiquid assets are only a small part of your total net worth, then this is not a big problem. Just be sure to consider this balance when deciding on a distribution rate and developing a retirement income plan. (AND financial advisor can help you estimate your net worth and create a retirement income plan.)
A man examines his assets and calculates his net worth.
If you rely on distributions from tax-advantaged retirement accounts, pay attention to the early distribution rules. Since you are not yet 59.5 years old, you will be subject to a 10% penalty in most cases.
However, there are known ways around this rule. If you have an IRA, you can take a look substantially equal periodic payments (SEPPs), which allow you to tap your savings before age 59.5 without incurring an early distribution penalty. Note that once you start a SEPP, they will continue on an annual basis for five years or until you reach the age of 59.5. Completing these payments before then will trigger a 10% penalty.
If you have a 401(k), rule 55 it can also help you access your retirement savings early. This rule allows you to make penalty-free withdrawals from your current employer’s 401(k) or 403b plan if you leave that job in the calendar year you turn 55 or later. (And if you’re deciding how best to increase your retirement savings, SmartAsset’s free tool can help you meet with a financial advisor.)
Your personal lifestyle, investment and risk tolerance preferences also play a role in this planning. It is very important that you do not neglect this. What may work for someone else may not work for you.
For example, if you are particularly risk-averse, you may be investing too conservatively and your portfolio may not grow enough to accommodate inflation-adjusted withdrawals. You’ll also want to make sure you factor inflation into your growth estimate.
On the other hand, if you’re a very aggressive investor (although it doesn’t sound like you are) and invest too much in stocks, you may be overexposed risk return order which could also derail you.
Again, I’m using extremes. There is a wide range between these points that works just fine. I’m simply illustrating the point that you should consider how your personal views on various aspects of your financial plan should influence your decision. (AND a financial advisor can help consider your lifestyle and other personal preferences when planning for retirement.)
A man reviews his finances on a tablet while enjoying a coffee in a cafe.
Most people will be perfectly capable of supporting a monthly retirement budget of $5,000 with $3 million, as long as it is sufficiently liquid and properly diversified. However, math is never the whole story. Be sure to consider how personal factors such as your risk tolerance and life expectancy might affect your financial plan in retirement.
Finding a financial advisor it 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 free introductory conversations 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.
Consider several advisors before settling on one. It’s important to find someone you trust to manage your money. As you consider your options, these are the questions you should ask a counselor to make sure you make the right choice.
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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Brandon Renfro, CFP®, is SmartAsset’s financial planning columnist and answers readers’ questions about personal finance and tax topics. Do you have a question you want answered? Email AskAnAdvisor@smartasset.com and you may have your question answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor is he an employee of SmartAsset, and was compensated for this article.
