Retiring with less than $500k in savings
Many people with less than $500k in retirement savings might think they won’t have enough for a great retirement and avoid the hard work required to make it the best it can be as that day approaches. Because financial planners are expensive and will only take you on as a client if you have more than $500k, you’re left to figure this out on your own. So let’s go over how to retire well with less than $500k.
In this discussion, I’ll assume you’re between 62 and 67, eligible for Social Security, and have only $400k in retirement savings at age 62. If your Social Security retirement benefit at Full Retirement Age (67) is $2,400 per month, retiring at 62 reduces it to 70% of the FRA amount, or $1,680 per month. Therefore, you’ll receive $20,160 per year at 62 or $28,800 at 67. I’ll also assume that before Medicare at age 65, you’ll need an ACA plan with a tax credit to keep health care expenses to $8,000 annually, and that all savings are held in tax-deferred accounts (401(k), Traditional or Rollover IRA) at the start of retirement. Finally, no other savings but a small emergency fund.
With less retirement savings, the #1 priority is capital preservation to make the money last as long as possible. This means living off the income the savings generate without drawing down the balance. Therefore, you need a strategy suited to your situation. It can’t be stressed enough, but with less savings, you must be more careful.
The widely publicized 4% Rule for retirement withdrawals means you withdraw 4% of your balance in the first year, then increase the amount by the inflation rate in subsequent years. This rule also assumes you’ll still be 50% to 75% invested in stocks. Because of the resulting volatility, you start withdrawals at 4% and increase them each year by the inflation rate. By age 80, you could be taking 6%. One problem with this rule is that stock volatility can erode principal, but over a 30-year retirement it should not run out. While you can follow the 4% Rule (or even a 4.5% Rule, which is riskier), an alternative is an income-portfolio strategy that can provide a steady 5% income* without inflation increases at the start (until needed much later in retirement; see note at the end).
There are two reasons why not inflating withdrawals isn’t as bad as it seems. First, Social Security provides a Cost of Living Adjustment (COLA). If it makes up half of your income, you’re left with the other half that doesn’t increase with inflation. Second, most people spend less as the years go by, with fewer dinners out, no more car or car insurance, no new clothes, or big vacations. As a result, the impact of inflation can be less than it would be otherwise, and an income-portfolio strategy can work for a decade or more before the principal is touched.
Finally, there is the option of a single-premium immediate annuity for ½ of your savings ($200,000) that can provide a higher, taxable income of 7.9% ($15,800 per year)**, plus $10,000 for the other ½ of your savings in a 5% income portfolio. If you wait until 67, that same $200,000 will buy an annuity paying $17,124. Note that these annuities, which can be purchased from a rollover or direct transfer from a tax-deferred retirement account, do not increase with inflation and instead guarantee income no matter how long you live.
Putting it all together, here is a summary of the two options for both ages:
You will need to live on $40,160 or $46,010 per year if you retire at age 62, or $53,800 to $61,424 if you retire at age 67. Of course, it’s much easier to live on $53,800 than on $40,160. And that’s before accounting for any increases in Social Security benefits from working longer and COLAs. I assumed, with conservative returns, that the $400,000 grows to $510,000 by age 67, generating more income. Considering all the factors, it is better and less risky to retire at 67 than at 62.
Can you live on the amounts shown? I can’t speak to your situation and location, but it should be possible in many places. Certainly, low housing expenses, either a paid-off home or a shared living arrangement, are probably required to keep housing under 35% of your income (about $1,000 a month), as is having a paid-off automobile or reliable public transit. But from a utilities, food, gas, maintenance, and insurance premiums standpoint, it can be done. Of course, couples would receive two Social Security checks, making it easier.
Now, we can’t avoid discussing taxes. While you might think only $20,000 in income from tax-deferred savings isn’t enough to be taxed, you’d be wrong. The combined federal and state tax bill at age 62 will be about $1,000, a significant hit to your budget. If you didn’t address this by converting some to a Roth account before 62, paying even more in taxes to convert after 62 is likely impossible once retired. If you convert at least $100,000 of the $400,000 years before 62, you’ll be able to avoid most taxes until your mid-80s, when the RMD pushes your taxable income above the standard deduction. Note that you’ll follow the 5-year Roth rule, which requires the Roth account to be established for 5 years before withdrawals are tax-free. Ideally, a Roth conversion would start no later than the mid-50s, and can be spread out over many years.
To be clear, you can do much better if you wait. You don’t need aggressive or risky investments, just time to compound further and claim a higher benefit.
Now, what if you really can’t wait? Before you press ahead with retiring at 62, I suggest evaluating what it would take to wait another year, and maybe another year after that. If finding work in your career field won’t happen, could you find work that pays just enough to cover your expenses? Here’s one way to think about it. Every year you wait, Social Security benefits increase by about 7%, while your savings grow by 5%. If you delay Social Security by a year and need $5,000 or $10,000 for unexpected expenses, you can always withdraw it from retirement accounts without penalty because you’re over 59 ½. And remember, the longer you work, the lower the other high cost of early retirement: health care.
It can’t be overstated that retiring before Medicare at 65 and Social Security Full Retirement Age at 67 can be costly, on the order of hundreds of thousands of dollars. Retirees with less savings cannot absorb that hit, if they can avoid it at all. But Father Time can’t be avoided either. As we get older, it becomes more difficult to hold a job and go to work, and that’s only possible if we’re not sidelined by a health challenge or by taking care of family. So, work as long as you can instead of thinking you’ll be able to go back later, because there may be no later.
In the earlier income discussion, I mentioned an Immediate Annuity. Of all the types of annuities sold, the only one I would consider is the Single Premium Immediate Annuity (SPIA). It is the simplest and carries the lowest commissions. One can receive a higher guaranteed income with the SPIA than with other income-oriented investments. That said, there are significant negatives with annuities, and you should defer a purchase to later years to get higher payments. But for those with less savings, an SPIA is a worthwhile option to consider in later years, say after age 70 or 75, to get a higher income from the annuity.
Finally, retirement expectations must be addressed when money is limited. Since time is our most valuable resource, you can use it in almost any way to bring joy and fulfillment. While it might cost a little gas money, volunteering can fill your days and reduce the urge to spend more money elsewhere. Yes, you’ll have to give up some costly habits, hobbies, and activities, but you can replace them with interesting, challenging, and productive ones. There are so many volunteer, craft, hobby, and even part-time work opportunities. All it takes is the desire to get off the couch or out the door. Thus, by adjusting our expectations of a larger lifestyle to one that fits the monthly budget, we can shape our retirement to be the best it can be.
Okay, now let’s discuss how to invest to achieve these results. To create an income portfolio, you can do it yourself (use some of the information in Volumes 2 and 3 of the “What Would Dad Do?” books and the FREE Income Portfolio spreadsheet downloadable here), find investing books at the library, or consult a financial services provider’s website Resources section. It’s not that difficult. You’ll evaluate funds and pick a handful that together will provide 5% to 5.5% in dividends and interest. Set up automatic withdrawals, then monitor performance and rebalance once a year. If you go the SPIA route, first read up on the Pros and Cons of annuities (see the discussion in “What Would Dad Do? - Volume 3”), then consult several online sellers, financial services providers, or insurance agents who sell SPIAs to get a quote. I would suggest doing the research and getting quotes, then sitting on the decision for several months. You can easily update the quote, but it’s a costly decision to reverse, so you’ll want to be sure that is the option you want to take. Alternatively, you could go to a fee-only financial planner for a one-time consultation to create the income portfolio for you and, likely through an associated insurance agency, to provide you with the annuity quote. The planner can and should act as a fiduciary with the investments but will pass you over to the commissioned agent to sell the annuity, so keep that in mind. Know that simple SPIAs are generally the lowest-commissioned annuities, and therefore you’ll be pitched other types of annuities that earn the agent more, but insist on the SPIA.
Retiring with less savings boils down to three things: minimizing expenses, investing for capital preservation and steady income, and setting expectations. But less doesn’t have to be worse if you put in the effort to do better.
Note: If the retirement savings are in tax-deferred accounts (Traditional IRA, Rollover IRA, or 4012(k), 403(b)), the Required Minimum Distribution (RMD) requires higher withdrawals after age 73 (currently). The required percentage doesn’t exceed 5% until age 81. Thus, you keep taking 5% income until age 81, and then start withdrawing more based on the RMD table, which will help offset inflation in your expenses. But don’t forget the tax implications of tax-deferred income, as discussed above.
* A 5% income portfolio is a reasonable goal today, although it could range from 4% to 6.5% depending on the investments chosen and their allocation. Striving for higher income can mean less potential for growth in value and higher interest rate risk, default risk, and risk of dividend cuts.
** The annuity amounts listed are examples (single male, Virginia, starting Oct. 2026) and were obtained from ImmediateAnnuities.com. They may vary by provider and by riders, such as term certain or return of premium.
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