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Retirement at 65 might be considered a little early for some. For anyone born after 1960, full Social Security benefits do not begin until age 67. Between ages 62 and 67 you can begin collecting benefits, but you will receive reduced payments for the rest of your life.
So if you’re looking to retire at 65, a core question is: Between your savings and your potential Social Security benefits, will you have enough income to cover your monthly spending?
For example, let’s say you’re age 60. You have $940,000 in an IRA and expect to receive $2,200 per month in full Social Security benefits. It’s likely that the answer is yes, as this may be enough to meet most budgets in most places. But it will ultimately depend on your specific circumstances and goals. Here are a few things to think about.
If you have questions about your retirement budget, taxes or goals, consider speaking with a financial advisor.
First, calculate your Social Security benefits. This is perhaps the most certain area in retirement planning. You can know exactly what you will receive, adjusted for inflation, year over year. If you choose to retire early or late, the Social Security Administration publishes clear guidelines for how it will adjust your benefits.
Here, you expect $2,200 per month in full Social Security benefits. This is what you would receive at age 67. If you retire at age 65, these payments will be reduced to 86.67% of full value. So, you would receive $1,906 per month/$22,880 per year in payments.
By contrast, you could maximize your benefits by waiting until age 70 to begin collecting Social Security. In this case, your benefits would increase to 124% of normal, or $2,728 per month/$32,736 per year. For people looking to retire early, timing your Social Security is important. In some cases, you might be better off drawing a little more from your IRA and waiting until age 70 to maximize benefits. In other cases, you might be better off taking benefits early to let your IRA grow more.
Here, we will assume you split the difference and take benefits at age 65.
Now, calculate your potential portfolio income. This is typically the largest segment of your retirement planning. It’s less certain than Social Security, but for most people generates more income.
Here, you have $940,000 in your pre-tax IRA. Setting aside additional contributions, the main question will be what your portfolio might look like by age 65 and what kind of returns it can maintain during retirement. This will depend significantly on your IRA’s returns and your capacity to manage risk and potential losses.
A financial advisor can help you make calculations based on assumptions and your goals. Use this free tool to match with an advisor. A few simplistic representative models include:
The average Aaa corporate bond pays interest of around 5% per year. Say that you keep your entire IRA invested in corporate bonds generating this 5% annual yield. In five years at age 65, you might have around $1.2 million in your IRA.
While bonds may have a lower rate of return than many other assets, they also have the significant advantage of being income assets. This means that you receive those interest payments without having to draw down on the underlying assets, giving a potentially indefinite retirement if your portfolio is generous enough.
Here, if you reinvest your annual yield, you might have $1.2 million at age 65. If you withdraw your 5% yield starting in retirement, that might generate about $60,000 per year. Combined with your Social Security, this might come to $82,880 per year of income starting at age 65. While your bond income will be exposed to inflation, you can sell assets from this portfolio to mitigate that risk over time.
Alternatively, retirees looking for security can consider purchasing an annuity.
Annuities are financial contracts typically sold by life insurance companies. Among other formats, a lifetime annuity pays you a guaranteed monthly income for life beginning at a fixed date. The amount you receive in payments depends on how much you invested.
Here, say that you invest all $940,000 in an annuity at age 60, then begin to collect payments at age 65. A representative product might pay you $7,566 per month/$90,792 per year for the rest of your life. Combined with your Social Security, this might generate $113,672 per year in payments for life.
That said, it’s important to remember that an annuity locks your money in place. Unlike market returns, your payments will not grow with inflation. And unlike bond investments, you cannot sell or otherwise liquidate these investments to mitigate that risk.
A financial advisor can help you weigh the pros and cons of different assets based on your circumstances.
Finally, you could invest heavily in the stock market.
For example, say that you invest your entire portfolio in a well-indexed S&P 500 fund. This might generate the market’s average return of 11% per year. If you leave this money in place for five years, it might grow to $1.58 million by age 65, with ups and downs along the way. In theory, then, in retirement this portfolio could generate $173,800 in annual returns alone, without ever drawing down on the underlying assets. Combined with Social Security, this might generate $196,680 in inflation-adjusted income starting at age 65.
While by far the most generous of our three representative options, the problem here is volatility and risk. In any given year your portfolio might generate significantly more than 11%, or it might generate less, or it might take active losses. Planning your retirement around stocks and market returns can work, as long as you can manage the down years. Because down years are not an if, they are a when.
Finally, it’s important to anticipate your tax requirements.
Since this is an IRA, you will generally owe income taxes on all of your withdrawals or income from this portfolio. You will also owe slightly modified taxes on your Social Security benefits. Here, very roughly, you will pay taxes on about 80% of your benefits.
You will also need to begin taking Required Minimum Distributions (RMDs) starting at age 73. The exact amount you must withdraw in RMDs will depend on your age and the amount in your portfolio in any given year.
You can eliminate both income taxes and RMD requirements by converting your traditional IRA to a Roth IRA. However, this would involve paying up-front conversion taxes. By the time you are at or near retirement, these conversion taxes typically exceed any likely savings on long-term income taxes.
Remember, a financial advisor can help you build a tax and retirement strategy.
Whenever you plan on retiring at 65, you should make absolutely sure your savings are ready. It will be hard to unring this bell, so look carefully at your Social Security benefits, your income and your capacity to manage risk before taking the leap.
Managing your income in retirement is just as important as growing your portfolio while you work. You want to balance long-term security with your very real need for growth during this stage of your life and, fortunately, we can help.
A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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