When it comes to estimating your retirement income, a popular rule of thumb is that you'll usually need about 80% of your working income to maintain the same standard of living. This comes from a number of factors, including the fact that you won't need to set aside money for retirement anymore.
This number is flexible, to be sure, and will vary from household to household. If you currently live significantly below your means, for example, then you probably can comfortably estimate lower. If you live paycheck-to-paycheck, you might want plan for either more income or fewer expenses. But 80% is a good place to start.
For example, let's say that you're 48 years old and currently make $95,000 per year. With $430,000 in a 401(k), what kind of retirement budget should you plan for?
Here's how to think about it. You can also consider using this free tool to match with a financial advisor to discuss the specifics of your situation and how to plan accordingly.
Your Spending and Expenses
Usually, we start with your money and build a budget from there. This time, though, let's start with your spending. Here, you make $95,000 per year. So with our back-of-envelope estimate, we'll start by assuming you will need about $76,000 per year/$6,350 per month to maintain your current standard of living ($95,000 * 0.8).
The math doesn't end there though.
Here, we have a couple of major moving pieces. First, at age 48 you may well have several expenses that you shouldn't expect in retirement. Most notably, spending or saving priorities related to dependents will likely fall off in retirement. Spending on your children or earmarked saving for college funds, for example, is a major part of your budget that you probably won't need in retirement.
On the other hand, you have roughly 20 years before full retirement age. That's a long time, with lots of room for your income and lifestyle to grow. This makes your future needs more difficult to forecast, since it's entirely possible that your standard of living will be based on more than $95,000 per year by the time your turn 67.
In general, do your best to anticipate the foreseeable changes to your life and needs. Beyond that, though, we can start by planning to maintain your current standard of living at your current income.
Budget For Taxes and Inflation
Next, remember the long-term costs associated with retirement. Most notably, your budget should always anticipate taxes and inflation.
When you collect income from a pre-tax retirement account, you will pay income taxes on the full value. In the same way that you currently live on no more than $74,571 after taxes, taking $76,000 per year from a retirement account would actually generate $61,205 in annual spendable income. Thanks to RMDs (required minimum distributions), you can't avoid these taxes indefinitely even if you have other sources of income.
That said, how you hold this money will affect your taxes. Money held in a pre-tax account, like a 401(k) or a traditional IRA, will be subject to full income taxes in retirement. Money held in a Roth IRA or a Roth 401(k) will be subject to taxes immediately, but none at all in retirement. And money held in a taxed portfolio will be subject to either capital gains taxes or income taxes based on the nature of the assets.
At age 48, a Roth conversion might be a good way to save money in the long term. You have enough time left before retirement that the up-front conversion taxes could be outweighed by the portfolio's long-term untaxed growth (possibly by quite a lot). The challenge would be liquidity. If you executed a one-year conversion plan you would owe at least $128,047 in conversion taxes. Since you're younger than 59.5, you can't take that money from your 401(k), so you'd need to find it elsewhere.
However you structure it, that money will also get less valuable over time as inflation gradually raises prices. In general, you should plan on increasing your portfolio withdrawals by around 2% each year to keep up with inflation, and your retirement plan should account for that.
Speak with a financial advisor for help building and executing a retirement strategy based on your goals and circumstances. They can help you project your needs in various circumstances, accounting for taxes, inflation and other factors.
Your Social Security
Once you have a sense of your likely future needs, the question is how it matches with your likely future income. Start by estimating your Social Security benefits.
You have enough working years left that this is still a rough estimate. Your future earnings will influence your Social Security credits, and might significantly increase your benefits if your earnings increase. However, based on your current earnings, we can start by assuming you will collect around $40,897 per year/$3,408 per month in 2025 dollars.
This is your estimate at full retirement age (currently 67). If you wait until age 70, you can boost that to a potential $50,712 per year/$4,226 per month. Again, these are base numbers. In future years, the more you earn the more you can increase your future Social Security benefits up to the program's maximum taxable income ($168,600 in 2024).
Your Savings and Combined Income
After you estimate Social Security we need to estimate your potential future portfolio income. Here, we start with $430,000 in a 401(k) at age 48. And that's great news because, even with a conservative portfolio strategy, you're currently in a strong pre-retirement position.
For example, let's say that you invest entirely in corporate bonds that pay the bond market's average 5% annual return. If you continue making 10% annual contributions and retire at age 67, you might have around $2.36 million in your portfolio upon retirement. Even with a conservative 4% withdrawal strategy this would generate $94,400 per year in portfolio income, for a combined income of $135,297 per year including Social Security.
On the other hand, you could choose a more aggressive strategy. Many financial professionals advocate that investors should focus more on equities during most of their earning years. So, here, say you invest in a mixed-asset portfolio that combines bonds and stocks to seek an 8% annual return. If you continue to make 10% annual contributions, in 29 years this portfolio might be worth just shy of $5 million.
With a 4% withdrawal strategy this might generate around $199,600 per year in portfolio income for $240,497 per year of combined income in retirement. This is more representative of your likely position in retirement than a pure-bond portfolio, since you should invest for more growth while you work. While this may seem like a lot more than you need, consider the fact that a 2.5% inflation rate over twenty years would make that $240,000 income actually worth about $146,000 in today’s dollars.
This gives us two basic answers to our headline question. First, a realistic retirement budget for your profile is $76,000 per year in today’s dollars. Based on your current income, this is likely the number that will allow you to maintain your current standard of living in retirement (adjusted annually for inflation). Second, a realistic retirement budget for your profile is also around $240,000 per year, or the equivalent of $146,000 in today’s dollars. Based on your current income, portfolio and reasonable growth projections, this is the income that your portfolio could realistically generate.
You are in a very strong position with this income and portfolio. Enjoy, and consider consulting a financial advisor for personalized advice.
The Bottom Line
There are two answers to a realistic retirement budget. First, the rule of thumb is that you will need about 80% of your current income to maintain your standard of living in retirement. Second, by estimating your Social Security benefits and likely portfolio returns, you can forecast what your portfolio will earn in the long run. Then, you just have to make sure the two numbers meet.
Tips
- Is that 80% number really right? It's a very useful rule of thumb, and is often correct for many households. However, let's make sure to look at how and why your spending might drop in retirement… just in case it doesn't.
- Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with 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.
- Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.
Photo credit: ©iStock.com/Yaroslav Olieinikov
The post What’s a Realistic Retirement Budget? I’m 48 With $430k Saved, Making $95,000 Annually appeared first on SmartReads by SmartAsset.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
