I met with a prospective new client this week and he asked me the question I get asked by most people during introductory meetings:
“When can I afford to retire?”
We spent about an hour working through some numbers and coming up with the answer. I thought seeing a real world example would be helpful to some of you, so I asked him if I could share the details as long as I kept his name confidential. Here are the basic facts:
- He and his wife are 61 years old
- He has worked for his current employer for 41 years
- His 401(k) is worth around $700,000
- They have another $600,000 in savings and investments
- His estimated Social Security benefits are $1,900 per month if he retires early at 62 and $2,500 per month if he waits until full retirement age at 66.
- His wife does not work outside the home and has not qualified for Social Security
- Their house is paid for and they have no other debt
- They need an income of $60,000 per year in retirement
Step 1 in deciding when to retire is answering the question “How much income do I need?” As George Foreman said, “The question isn’t at what age I want to retire, it’s at what income.” In this case, the client (Let’s call him Jim) wants to have about $60,000 per year gross (i.e. Before taking out taxes).
Step 2 is figuring out where that money is going to come from. If Jim retires at 62, he will get $1,900 per month from Social Security. That’s $22,800 per year. He wasn’t expecting his wife to receive any Social Security because she hadn’t worked the 40 quarters required to qualify. Needless to say, he was happy when I told him that she qualifies for a spousal benefit. Spouses are entitled to receive the higher of their benefit (in this case $0) or half their spouses benefit (in this case $950 per month). That adds another $11,400 in income per year.
So they need a total of $60,000 and $34,200 of that is coming from Social Security. That means their personal investments will need to generate the remaining $25,800. Is their nest egg up to the task?
They have a total of $1,300,000. As we have discussed here many times before, research shows that a safe withdrawal rate from a portfolio is around 4 percent. Taking a 4 percent withdrawal from their portfolio would get them about $52,000 per year, which more than covers the $25,800 they need. So looking at the numbers, Jim and his wife could afford to retire at 62. But should they? I advised him to seriously consider waiting a few years. Here’s why:
- They will almost certainly need more income than they are expecting. Jim told me that his $60,000 estimate is the absolute minimum they’d need to maintain their lifestyle. If anything unexpected happens and they need to draw more, they could run out of money sooner than expected.
- They are both in good health and have parents that are alive and in their nineties. Given their health and family history, there’s a good chance that they will live for a long time. If that’s the case, their money needs to last. Working for a few more years not only gives them a chance to save more, but also means that they won’t be drawing income from their savings yet, which will help it last longer.
- The breakeven point on their Social Security (where it makes sense to wait until full retirement age to claim benefits) is about 12 years. That means if they plan on living past age 74, it probably makes sense to wait to begin collecting benefits until full retirement age rather than taking a reduced benefit at 62.
- Another potential reason to wait is health care. Right now, Jim’s employer pays the cost of his health care, but that would stop if he retires. Since he and his wife won’t be eligible for Medicare until age 65, retiring now would mean either going without health care or paying out of pocket for coverage. To continue his current coverage using COBRA would be about $900 per month. Waiting to retire until they are eligible for Medicare would eliminate that expense.
- Finally, we’re living in an uncertain time. Inflation is tame now, but could easily get much worse. The markets are volatile. Interest rates are low. All of these things can damage a portfolio’s ability to generate enough income.
Conclusion: Jim and his wife can afford to retire now, but as long as they’re in good health and Jim is relatively happy at his job, waiting could greatly increase their security during retirement. I hope that example helps shed some light on the process of deciding when you can afford to retire. Touch base if you have any questions or if there’s ever anything I can do for you.