What can I actually spend each month without running out of money? This is one of the most important questions that retirees ask. And one of the hardest to answer. Many people rely on rough estimates, but guessing wrong early in retirement can cost you big for decades.
What $720k and $1,900 Per Month Really Translate To
A $720,000 401(k) is a lot of money. But the balance matters less in retirement than the income it can provide. Many retirees use a withdrawal-rate strategy to estimate how much they can spend each month, with the goal of making their savings last for the rest of their lives.
Using a moderate withdrawal rate of 4%, a $720,000 portfolio could earn roughly $2,400 per month ($720,000 x 4% = $28,800 per year, or $2,400 per month). Combined with $1,900 in monthly Social Security benefits, that puts total gross retirement income at roughly $4,300 per month ($2,400 + $1,900 = $4,300).
One exception to note here: This is not necessarily what ends up in your checking account. Taxes, Medicare premiums, healthcare costs and other expenses can all reduce the amount available for your day-to-day spending. You should also keep in mind that investment returns will vary from year to year, which may affect how much can be safely withdrawn over time.
For these reasons, retirement planning requires you to look beyond the simple addition of account balances and Social Security benefits. Life expectancy, investment strategy, inflation and future healthcare needs will all impact how much you can comfortably spend without increasing the risk of running short later in retirement.
Three Deductions That Can Shrink Your Real Budget
Retirement income looks different on paper than it does in your bank account. These deductions can eat into how much you could actually spend:
- Taxes. Withdrawals from a traditional 401(k) are subject to federal income tax and, in most places, state income tax as well. So, depending on your bracket, a significant cut of each withdrawal may never make it to your checking account.
- Healthcare. Medicare premiums are commonly deducted from Social Security benefits, and higher retirement income can sometimes trigger additional premium surcharges. Earning more income from retirement accounts does not always translate into a dollar-for-dollar increase in spending.
- Inflation. Even if your income remains steady, prices will not stay the same. Therefore, a $4,300 monthly budget today may cover much less one decade from now. This makes it important to plan around what your money can actually buy, and not just how much you receive.
A retirement advisor can help you account for all three and build a spending plan around what actually reaches your bank account.
Why the First Five Years Can Shape the Next Twenty-Five
One of the biggest retirement risks is not how the market performs over the course of retirement, but how it performs in the first few years.
If markets fall early in retirement while you are making withdrawals to cover living expenses, those withdrawals can lock in losses and leave less money invested for a future recovery. This is known as sequence-of-returns risk, and it can shorten how long a portfolio lasts.
To put this into perspective, two retirees could earn the same average return over retirement, but the one who faces losses early may end up with substantially less money later. As an example, let’s compare one who earns 7% annually for the first five years and another who loses 7% annually during those same years.
| Year | Retiree 1 (7% Gain Each Year) | Retiree 2 (7% Loss Each Year) |
|---|---|---|
| Start | $720,000 | $720,000 |
| 1 | $741,600 ($720,000 × 1.07 − $28,800) | $640,800 ($720,000 × 0.93 − $28,800) |
| 2 | $764,712 ($741,600 × 1.07 − $28,800) | $567,144 ($640,800 × 0.93 − $28,800) |
| 3 | $789,442 ($764,712 × 1.07 − $28,800) | $498,644 ($567,144 × 0.93 − $28,800) |
| 4 | $815,903 ($789,442 × 1.07 − $28,800) | $434,939 ($498,644 × 0.93 − $28,800) |
| 5 | $844,216 ($815,903 × 1.07 − $28,800) | $375,693 ($434,939 × 0.93 − $28,800) |
By year five, the first retiree has about $844,000 remaining, while the second has about $376,000. Both averaged the same return over time, but in a different order. Because the second retiree had to make withdrawals during market declines, far less money remains invested and available to benefit from future growth. Working with a financial advisor before retirement could help you build a withdrawal strategy that accounts for this risk from the start.
Photo credit: ©iStock.com/Miljan Živković, ©iStock.com/SeventyFour
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