Week 8: Timing Your Retirement

Course Progress:

“There’s never enough time to do all the nothing you want.”

— Bill Watterson, Calvin & Hobbes

Last week we covered some popular retirement strategies. But you may still be wondering: Will I have enough? And what will my retirement look like?

I held back a little to avoid overwhelming you with a bunch of new concepts and the math behind them. But now it’s time to learn to fish, learning to use the tools professionals use to plan and compare retirement scenarios.

First, I’m going to run through some quick examples of what various plans might actually look like in real life.

A few assumptions

Our friends Sam and Sally Sample are here to help us out.

Here are the assumptions we’ll work with:

Sam and Sally Sample's Retirement Plans
Sam's current age 60
Sally's current age 58
Amount in Sam's retirement plans $300,000
Amount in Sally's retirement plans $200,000
Amount of Social Security Sam will get at 62 $1,421
Amount of Social Security Sam will get at 66 $1,990
Amount of Social Security Sam will get at 70 $2,766
Amount of Social Security Sally will get at 62 $1,078
Amount of Social Security Sally will get at 62 $1,494
Amount of Social Security Sally will get at 62 $1,765

About these assumptions:

  • Savings amounts. I assumed Sam makes $75,000 annually and Sally makes $50,000. According to Fidelity, by the time you reach 60, you should have eight times your annual salary saved for retirement.
  • Adjusting for reality. For Sam, that should be $600,000 and for Sally, a little shy of $400,000. But since most Americans don’t save as much as they should, I arbitrarily reduced those amounts. (If you don’t have anywhere near that much saved, don’t feel bad. According to the Government Accounting Office, half of households age 65-74 have no retirement savings at all!)
  • Social Security estimates. These numbers came from the Social Security Quick Calculator.

Now, let’s harness the numbers and try out a few scenarios.

Scenario 1: Early retirement

Sam, 60, and Sally, 58, both retire at 62:

  • Their combined Social Security will be $2,499 monthly ($29,988 annually).
  • Sam contributes $5,000 annually to his 401(k). If the account earns 5 percent, at 62, his current $300,000 balance will be about $342,000.
  • Sally contributes $3,000 annually. At a 5 percent return for the next four years, her $200,000 401(k) will have grown to about $227,000.
  • They plan to supplement Social Security with 4 percent withdrawals from their 401(k) plans: Sam will withdraw $13,680 the first year and Sally about $9,000. (Since they’re withdrawing 4 percent and earning 5 percent, they should be able to maintain that level of withdrawal.)
  • Their combined annual income, when both are retired in four years: roughly $53,000.

Conclusion: Will this be enough income for Sam and Sally? Social Security is somewhat protected from inflation by small, periodic increases. But if they keep withdrawing nearly as much as they’re earning from their 401(k) plans, inflation could gradually shrink their savings.

Read: “18 Moves That Will Help You Retire Early and in Style”

To test any of these plans, they will compare the income numbers with their retirement vision (Week 1) and their projected retirement spending (Week 3).

Scenario 2: 70 is the new 65

Sam and Sally work until they’re 70 and 68 respectively, retiring in 10 years:

  • Their combined Social Security will be $4,531 monthly ($54,372 annually).
  • By contributing $5,000 annually and earning 5 percent for 10 years, Sam’s 401(k) will be about $550,000.
  • With Sally’s $3,000 annual contributions, at 5 percent, her 401(k) will be about $365,000.
  • When Sam turns 70 ½, he’ll be required to withdraw about $20,072 from his 401(k) to satisfy IRS required minimum distribution rules, bringing his total income to $74,444.
  • Sally, at 68, will not be required to take a distribution. But if she takes the same 4 percent as Sam — $14,600 — their combined annual income would be $89,044.

Conclusion: If Sam and Sally work until 70 and 68, they’ll earn 70 percent more than by retiring at 62.

Scenario 3: Social Security + Required Minimum Distribution

In this scenario, Sam and Sally will wait to apply for Social Security until he’s 70 and she’s 68, giving Sam the maximum benefit and Sally’s benefit a boost. They will quit work at 66 and 64, living off 401(k) withdrawals until their optimized Social Security kicks in.

  • For the next six years, Sam contributes $5,000 a year to his 401(k). If his savings earn 5 percent annually, his balance will be roughly $438,000 when’s he’s 66.
  • At the same time, Sally contributes $3,000 annually, for an estimated $290,000 401(k) balance when she’s 64.
  • Their combined balance: about $728,000.
  • Upon retiring, they’ll withdraw 5 percent ($36,000) each year for four years.
  • They claim Social Security when they reach 70 and 68: $54,372 annually ($4,531 a month) combined.
  • When Sam turns 70 ½, he must withdraw $16,000 as a required minimum distribution from his 401(k) (balance: $438,000).
  • The couple’s total income: $70,372. That includes $54,372 in Social Security and $16,000 from Sam’s retirement account.
  • Optional: Sally takes a 4 percent distribution from her 401(k), adding $11,600 to their pot for an annual combined income of $81,972.

Conclusion: If Sam and Sally work until 66 and 64, and then live off their retirement plans for four years, they’ll end up earning $82,000 each year when they are 70 and 68 — only $8,000 less than they’d make working four more years.

But this also requires they live on $36,000 a year for those four years between retirement and collecting Social Security, which may prove difficult, if not impossible.

Read: “7 Ways to Know If the Time Is Right to Retire”

Here’s a comparison of the three options:

Sam and Sally Sample's Retirement Scenarios
Early retirement (both 62) 70 is the new 65 (70 and 68) SS/RMD strategy (66 and 64)
At retirement 4 years later
Combined Social Security per month $2,499 $4,531 $0 $4,531
Combined Social Security per year $29,988 $54,372 $0 $54,372
Sam's 401(k) after $5,000 per year at 5% until retirement 2 years ➙ $342,000 10 years ➙ $550,000 6 years ➙ $438,000
Sally's 401(k) after $3,000 per year at 5% until retirement 4 years ➙ $227,000 10 years ➙ $365,000 6 years ➙ $290,000
Sam's 4% 401(k) withdrawal $13,680 $20,072 $16,000 $16,000
Sally's 4% 401(k) withdrawal $9,000 $14,600 $11,600 $11,600
Total income $53,000 $89,044 $36,000 $81,972

You can do scenarios like this yourself!

I used simple online calculators to supply the numbers you just read. The entire process for each of these scenarios took less than 10 minutes.

And this, gentle reader, is exactly what a professional planner would do for you.

Well, almost. They wouldn’t use the simple online calculators I used; they’d use more sophisticated software created for this purpose.

What’s important is to know what’s behind the financial planner’s curtain. You no longer have to pay a fisherman. Now, you know how to fish.

All you need is practice, which you’re about to get — right after we discuss one other big worry about timing your retirement.

What if the economy gets bad?

Few ever feel ready for retirement, but tumbling stocks can shake the confidence of even the most prepared.

And with the stock market posting its worst year in a decade in 2018, you may be strongly tempted to make a move. Should you?

That depends on where you’re at and your appetite for risk. Let’s talk it through, starting with the simplest and safest options and moving toward riskier and more complicated ones.

Work longer (or go back to work part-time)

The less you have to dip into your investments at what may be their lowest, the more potential and time they have to recover.

It’s also possible the market could go even lower; neither you nor any expert has a way to know for sure.

That means if your health and situation allow, continuing to work is the safest step to take — it gives you opportunity to keep growing your nest egg instead of raiding it.

Even if you can’t do full-time, you may have more options than you realize, from taking on a project-based or consulting role at a previous employer to part-time jobs that didn’t exist a few years ago.

We’ll talk much more in-depth about working before and during retirement in a couple weeks. For now, check out 12 Ways Retirees Can Make Money Through Passive Income and consider a service like FlexJobs, a subscription-based jobs board that manually screens work-from-home jobs and other flexible job postings.

Wait it out

This is kind of self-explanatory, and the stock advice everyone hears during bad times: Sit tight and wait for the market to recover.

Yes, your situation is more pressing than people who have several more years of work ahead of them. But to the extent you can, avoid touching your investments and otherwise proceed as planned with your retirement.

This is the simplest course if you’re not in a position to continue working or pick up work. It’ll go smoothest if you already have enough cash to cover a couple years’ worth of living expenses.

If you’re not yet drawing Social Security and younger than 70, there’s one more big benefit of waiting we’ve already discussed: You can boost your Social Security checks permanently.

Examine your portfolio

This might give you the peace of mind for the option above or spur you to make some needed changes. If you don’t already know the answer, now’s a good time to figure out: How prepared are you to weather a financial storm?

For a starting point, look back to Week 6 and see how you compare with our asset allocation rule of thumb: 100 minus your age as a percentage of your portfolio in stocks. The rest should be evenly split between bonds and money market funds. If you have enough in a liquid fund, this might be exactly the rainy day you planned for.

Are you too heavily invested in stocks? Are you safely diversified in index funds, or dangerously concentrated in a sector that might get hit harder? What are the fees like on your accounts?

More importantly, what does your gut tell you about the possibility the market could drop by half, as it did during the Great Recession? Is that something you can handle?

These are questions you should be asking yourself regularly, and long before the economy sours. But the questions — and the guidance they provide — is valid all the time. Check out Year-End Review: Evaluate Your Retirement Accounts in 15 Minutes or Less for a walk through.

Reset your expectations

Here’s another retirement rule of thumb: Plan to withdraw 4 percent of your initial retirement portfolio for your first year of retirement, and then keep pace with inflation in the following years. That should give you about 30 years’ worth of money to work with.

A downturn can obviously blow that all up. If you start making higher withdrawals, you’ll eat through your retirement fund more quickly.

So it’s time to do some math: Could you live on 4 percent without adjusting for inflation for a few years, until the market recovers? If you can tolerate a little squeeze now, you’re less likely to face a far bigger squeeze later.

It’s much easier to adjust your expectations than your portfolio. You can tighten your belt now and loosen it later; your investments aren’t quite as flexible.

Ask for help

We also talked in Week 6 about whether you need a financial adviser and how to pick one. Even if you you’re not looking for a long-term relationship, you might just want a professional to evaluate your gut reaction to a downturn and calm your nerves.

Once again, rule out commission-based advisers and look for someone who will charge you by the hour, just like an accountant would.

Consider an annuity

If all the variables of retirement are becoming too overwhelming, an immediate annuity is another option which could provide some consistency and simplicity.

An immediate annuity is essentially a pension, but from an insurance company — you pay them a lump sum, and they pay you a guaranteed monthly income for the rest of your life. Paired with Social Security, you could worry far less about what the market is doing.

Sounds straightforward, but it’s this far down the list of suggestions for a reason. There are several kinds of annuities, and they can get quite complex and full of fees. We’ll spend all of next week discussing products like annuities.

Roll the dice

The thinking behind the asset allocation rule of thumb is to continually rebalance your portfolio to reduce your risk as you age. The less of your money you have tied up in the stock market, the less you need to worry about the market tanking.

This limits the nightmare scenario of a sudden shortfall — but it also arguably increases the danger of a gradual one. Once you take your money off the table, it can no longer grow at the rates it had been. There is always the risk you have more years than money.

What if you didn’t walk out of the market, but instead held your investment steady, or even doubled down by increasing the percentage of your portfolio in stocks? Of course, challenge the conventional wisdom at your peril.

Your task for this week

OK, that’s enough talk about the economy. Let’s do some math.

The goal of this exercise is to see, while there’s still time to make changes, how your decisions will affect your retirement income numbers.

Chart out your own retirement scenarios!

  • Estimate your Social Security here. This tool will give a quick rough estimate, which you can refine to be more accurate. It doesn’t access your Social Security record, so it makes assumptions about your earnings that you can manually correct year by year with actual earnings. (To do this, click on “See the earnings we used” after receiving your results.)
  • To determine what you’ll have in your retirement plan in the future, use MoneyChimp’s easy compound interest calculator.
  • Estimate required minimum distributions. The Financial Industry Regulatory Authority’s RMD calculator asks just two questions.

Download: Week 8 Worksheet: My Retirement Scenarios

Make your own timelines and contribution amounts as realistic as possible. Think through and map out three complete scenarios that might apply to you, using the scenarios in this chapter as your guide. The goal is to see how your decisions affect the numbers while you still have time to chart a new path to retirement.

  Week 8: Feedback