When it comes to determining whether you have enough money to retire, chances are you’re focused on the balance in your 401(k) or other retirement plans. After all, the more money you have invested, the more financial security you should have.
However, the balance alone isn’t the only number that matters. Here’s another key factor to consider when determining whether you’re prepared to retire without money worries.
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This number matters as much as your 401(k) balance
The other key number that makes a huge impact in retirement is your withdrawal rate.
That’s the rate at which you take money from your retirement plans. For example, if you have a nest egg of $1 million and withdraw $60,000 each year for income, you’d have a 6% withdrawal rate.
Your withdrawal rate matters because if you withdraw too much money too quickly, you will not have enough invested to earn the returns you need to maintain your account balance.
This is true even if you have $1 million or more. In fact, say you wanted to withdraw $10,000 per month on your $1 million balance, you were earning 6% returns before taxes, your federal tax rate was 22%, and you wanted to increase withdrawals by 2% annually to account for inflation.
Unfortunately, with this approach, your $1 million would last only around 10 years. For most people, that is not nearly long enough.
What is a safe withdrawal rate?
So if you need to make sure you don’t withdraw too much from your 401(k) or other retirement accounts, the question becomes: What is a safe withdrawal rate?
Traditionally, many experts recommend that you follow the 4% rule and withdraw 4% in the first year of retirement, then adjust it based on inflation. However, lower anticipated future returns and longer life expectancies could mean your money doesn’t last if you stick with this common approach.
You could be more conservative and withdraw, say, 3.5%, if you’re worried about your funds running out. Or the most conservative approach would involve withdrawing only returns or dividends paid, leaving the principal balance alone. However, this would require careful retirement planning, as you would need to save much more with this approach.
You can also develop a personalized plan on your own using online calculators or with help from a financial advisor who understands the specifics of your situation, including your investment mix and financial goals.
The key is to have a plan for safely withdrawing your funds. Because if you don’t, even a big IRA or 401(k) balance could disappear very quickly, leaving you in serious financial trouble in your senior years.
