Can you retire now? Here's how to tell.
Savings, desired standard of living, and income sources all factor into how soon you can retire. But if you want a quick answer, the '4 percent rule' is a good place to start.
If you’re nearing retirement age, you may be asking yourself, “Can I retire now?” As a financial planner, I get this question a lot. My initial answer is almost always, “It depends.”
When my clients start thinking about this question, we have a preliminary discussion about the key factors that affect the answer. The top five considerations are:
- How much money have you saved?
- What kind of standard of living would you like to maintain?
- What sources of income will you have (e.g., Social Security only, or one or more pensions)?
- How old are you now and how long do you think you will live? I typically recommend that you plan your finances as though you will live until at least age 90, if not 100, unless your parents and grandparents had significant health issues.
- What kind of investment returns can you expect? This factor is not in your control, but is a critical part of answering, “Do I have enough money to retire?”
Rule of thumb
If you just want to know if you’re even in the ballpark, there’s a quick and dirty method you can use. In the 1990s, former financial planner William Bengen developed the “4% Rule.” The rule basically holds that retirees can withdraw 4% (adjusted for inflation) from their investment portfolios each year and never run out of money.
More recent research indicates that this may not be as reliable an estimate as initially thought. Depending on your circumstances, withdrawing 4% may be too aggressive and could result in the depletion of your financial reserves in retirement, particularly if financial markets drop significantly early in your retirement years. However, there also are some circumstances where you might be able to withdraw from your savings at an even higher rate, particularly if you’ve worked into your 70s and have a shorter retirement horizon.
Doing the math
However, as a basic rule of thumb, applying the 4% rule to your own situation can give you a sense of how prepared you are to retire and what you may need to do to get there. Here’s an example of how you can use the 4% rule as you near retirement age.
Let’s say you are nearing retirement and you:
- Are eligible for a monthly Social Security benefit of $3,500 per month.
- Are married and have a spouse who is eligible for a Social Security benefit of $2,500 per month.
- Have $750,000 saved in retirement assets.
- Estimate that you need an income of $100,000 a year before taxes to maintain your desired standard of living.
Using the 4% rule, you’ll be able to withdraw $30,000 ($750,000 x 0.04) per year from your investment accounts for living expenses. To this, add your annual Social Security benefit of $42,000 ($3,500 x 12). And also add your spouse’s Social Security benefit of $30,000 ($2,500 x 12). Total it all up and you get $102,000 ($30,000 + $42,000 + $30,000), which is slightly more than you need to cover that $100,000 in estimated annual living expenses.
What the math tells you
Scenario 1: Pack your bags…
If you plug your numbers into the 4% rule and can cover at least one and a half times your projected living expenses, it’s probably OK to grab the golf clubs and fishing rod. Confirm your math with your financial advisor and congratulate yourself on a job well done with your retirement planning!
If your numbers shake out like the example above, you may want to take a closer look at whether it would be enough.
Scenario 2: Pack your briefcase…
If you’re on the opposite end of the spectrum and can cover less than half of your projected living expenses, it’s probably time to revisit your assumptions given the current reality of your finances. Plan to do one or more of the following:
- Delay retirement a few years by staying with your current job. This will enable you to accumulate more money in yourretirement accounts and reduce the number of years you’ll need to draw from your savings.
- Pursue an “encore career” either part or full time to supplement your income.
- Consider a reduced lifestyle compared to what you initially planned. You can explore moving to an area with a lower cost of living or think about going out to dinner twice a month instead of twice a week. Weigh the benefits of working a few more years versus trimming expenses and decide which you prefer.
Scenario 3: Take a closer look
If you’re somewhere in the middle and can cover between half and one and a half times your projected living expenses when you use the 4% rule, reach out to your financial advisor for help with putting together a comprehensive retirement plan. Your advisor will take a variety of factors into consideration and help you understand exactly where you stand in terms of retirement.
If you’re asking, “Can I retire now?,” grab a pencil, some paper and a calculator and take 10 minutes to work through the 4% rule. Knowing where you stand can help you decide your next step as you plan for what I hope is a wonderful and fulfilling retirement.
This article first appeared in NerdWallet.
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