Retire at 60 on $1.5M?
Always ready to crunch numbers, I came across a Yahoo! Finance headline that caught my attention: “Retirees Are Realizing a $1.5 Million Nest Egg at 60 only means $31,000 in Real Annual Spending.” The article’s main point was to reality-check how much of what seems like a large retirement account can actually be spent if you retire at 60. According to their calculation, it’s only $31,000 a year. So, can you retire at 60 with $1.5M? Their answer is: “maybe.”
But is the “maybe” answer correct? For most of us, $1.5M seems like a lot of money, and saving that much suggests we’re probably pretty good at managing our finances. But the reason the answer could be “maybe” is the 5- or 7-year window from 60 to 65 or 67. At the later age, when Social Security and Medicare are in place, the math changes significantly. Early retirement is a different animal. Let’s explore some of the details of such a scenario.
First, the author notes that before age 65, when Medicare coverage begins, someone might need to spend $1,000 a month on ACA health insurance and face higher taxes because all income must come from tax-deferred accounts and is therefore taxed as income. Even if a $400,000 home is paid off, property taxes remain high. Next, the author explains that the scenario is risky because a 3.5% safe withdrawal rate, assuming a 35-year retirement, produces only $52,500 in income from $1.5M. Then, taxes, health insurance, property taxes, and homeowners insurance reduce that amount to $24,000 in real annual spending. At age 65, it increases to $31,000 due to Medicare reducing health insurance expenses. The author goes on to list key expenses: $500 monthly for food, $250 for gasoline and car insurance, $300 for internet and utilities, etc. Thus, the author concludes that it’s probably not enough.
Now that I’ve laid out the scenario described on Yahoo!, how would Mr. Tom approach this question? The first step is to confirm every line item in your annual budget at age 60 and estimate changes at 65 with Medicare and at 67 when Social Security is claimed. Let’s start with health care. Before age 65, when Medicare starts, you need health insurance from age 60 to 65. Without employer coverage, you’ll buy a policy in the ACA marketplace. In my state of Virginia, a GOLD plan without a tax credit subsidy is about $1,000 a month (but if you could live on $62,000 or less, a $442 monthly tax credit is available). Next are property taxes and home maintenance. For a $400,000 house in my area, property taxes are about $3,600. Add $250 a month for maintenance, and the total annual housing expense is $6,600. Finally, there are taxes. The article stated that federal taxes would be an effective 15% tax rate ($7,875) and that a 5% state tax would be $2,625, but that ignores a real tax calculation, which results in about $2,500 less than the federal tax stated in the article.
To estimate retirement income at 60, the author stated that the retirees’ $1.5M was split between taxable and tax-deferred accounts. If the split was 1/3 taxable and 2/3 tax-deferred, that provides some options. First, one option Mr. Tom likes is to split the taxable $500,000 into $100,000 for emergency savings and then put $400,000 into Municipal Bonds, which today pay 3.75%, generate $15,000 annually, and are tax-free. The $100,000 emergency fund stays in a Money Market Fund earning 4.5% interest, or $4,500 per year.
While you should choose a lower safe withdrawal rate for a longer retirement, 3.5% is far below what an income portfolio can generate. I agree that keeping 40% or more in stocks and using a lower withdrawal rate can buffer years with negative returns, but there is a better way. Use a more income-focused portfolio from ages 60 to 67. An income portfolio can reliably produce 5% to 5.5% in income with a much lower risk of having to draw down the principal. Think about it this way: if you can live off interest and dividend income until you claim Social Security, you have considerably lowered investment risk until Social Security replaces that income with a guaranteed income. At that point, you can shift your portfolio toward more growth to achieve a higher long-term return and ensure your money lasts until the end.
For example, today Floating Rate Bank Loan Funds yield 7%, High-Yield Corporate Bonds at 6%, Emerging Market Government Bond funds at 5.5%, and Intermediate Term Bond funds at 5%. High Dividend Stock ETFs yield 4.5%, REITs distribute 5%, and Preferred Stock ETFs yield 5.5%, with many other options available to build a portfolio that achieves dividend income of 5% or higher. Thus, a well-diversified income portfolio - using only a few funds - will produce $50,000 per year without drawing down principal for the $1M tax-deferred portion. The retiree thus receives a total of $69,500 in annual income without drawing down principal. If there were a steep drop in stocks, this type of portfolio may decline by only a third of what traditional stock/bond portfolios would.
The five years before and five years after a retirement date are the riskiest years for retirement savings because losses during withdrawals have a magnified effect on the principal balance. By producing sufficient income from the portfolio, shares are not sold, thus delaying the drawdown of the balance until after Social Security is claimed. At that point, if desired, the portfolio can be adjusted to a less conservative posture because Social Security is providing a sufficient portion of the income.
Next come other living expenses, including food, electricity, and insurance, which have risen significantly in recent years. When laid out in an annual budget that includes taxes and health insurance, the individual can live pretty well on $61,000, about $8,500 below their income, and might qualify for the ACA tax credit. Being 12% under budget is more than a sizable buffer for the unexpected; 5% would be sufficient. The obvious reason that this could work is the paid-off house and no car payments (I did include $1,200 for car repairs). By owning a house, they have an equivalent ~$1,000 (or more) per month in housing costs covered, which could be less than half the cost of a rental. However, including a new car payment blows up the budget, as new cars today are in the $35,000 to $45,000 range, and many are financed for 5 to 7 years. The problem is eliminated if the retiree ensures they own a reliable, not-too-old car heading into retirement at 60, allowing them to delay a replacement until on Social Security, when more income is available. Alternatively, they can make the car payment work by increasing withdrawals by 0.5%, which may only dip into the $1.5M principal by $7,000 a year.
As I said at the start, the calculation changes significantly at age 65, when Medicare starts, and again at 67, when Social Security begins. That $1,000-a-month ACA policy could become a $213 Medicare Part B premium and a $250 Medicare supplement, which halves the health insurance expense. Social Security might bring in $2,500 or more per month, which either reduces withdrawals from retirement savings or increases income for more spending (and finally, that new car or some additional travel).
In summary, the article made some errors, in my view, mostly because it didn’t work through the details, which can lead to large differences in the result. Even a few assumption errors can add up. The article didn’t mention the likely impact of spending reductions as one ages, or the cost of elder care. A 20-, 30-, or longer retirement is really multiple stretches of time with different expenses, tax rates, and risks to address. And while a paid financial advisor can build a good income portfolio, you’ll also have to find the $10,000 or more in your budget to pay them every year.
But the article did raise the key point that a large sum of retirement savings may not be enough for an early retirement. Anyone who saves $1.5M might think that’s enough without crunching the numbers. The $1.5M at 65 is worth a whole lot more than $1.5M at 60. Retiring early is costly not just because of health insurance but also because it means drawing from savings years earlier, rather than continuing to compound growth. It’s risky from a longevity and sequence-of-returns standpoint, and it leaves one exposed to other risks with no income to fall back on for many more years.
Of course, everyone’s situation is different, shaped by factors such as geography, fixed expenses, health care needs, and account balances. While I believe $1.5M could support early retirement, that’s only possible if you plan for it by eliminating mortgage payments and living frugally. But the answer varies by state because of taxes and the cost of living. Before considering early retirement, make sure to do thorough number crunching or seek help as needed. Tools like my Ultimate Budget and Retirement Yearly Plan can help you evaluate and stress-test the plan you create.
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