Many people are curious about how they get money from their retirement accounts once they have stopped working. This month, I wanted to help illustrate how distributions work, and the effects that unplanned distributions can have on a retirement portfolio.
Let’s say you saved a nest egg of $250,000 in your employer-sponsored plan. Now, you are retiring and eagerly looking forward to receiving the fruits of your labor.
Based on a 5% withdrawal rate, your monthly “retirement paycheck” would be approximately $1041/month (before taxes). We use a 5% rate because we believe that is a reasonable average rate of return for most moderate portfolios over time. Withdrawing this amount means potentially sustaining the original account value (in this case, $250,000) over your lifetime.
But then let’s say you unexpectedly decide to take out $25,000 to pay for a medical bill or a new car. That leaves your portfolio with a balance of $225,000. Applying the same 5% withdrawal rate to the reduced balance would provide a new monthly income of $937.50. In effect, you have just given yourself a $103.50/month pay cut. Ouch!
So, how can you sustain a healthy retirement income and meet life’s unexpected demands? Here are three things you can do:
First, everyone should have an “emergency savings” account, to help you deal with life’s emergencies. The rule of thumb is to have at least 3-6 months’ worth of expenses (not income) stashed away in your emergency savings account. So, if your monthly bills average around $3,000, then you would aim for having $9,000 to $18,000 in emergency savings. This creates your first line of defense when the unexpected happens.
Second: for bigger accidents, often that’s where insurance comes into play. You may want to consider reviewing your health, disability, and/or life insurance policies and options. Play the “what-if” game: ask yourself, “what happens if… I can’t work for an extended time, or I am unable to care for myself?” What insurance policy would potentially come into play, and how much money would it provide?
Third: plan and save for big purchases over time. Let’s go back to the car example. If you started a “car savings account” and put in $350/month, you could have enough for your car purchase in less than 6 years (and that’s assuming a 0% interest rate!). It takes time, but doing this could potentially prevent your future self from facing a $103.50/month pay cut for the rest of your life.
I hope this helps you to realize the importance of proactive planning. Please feel free to contact us with any questions you may have about your particular situation and what you can do to avoid a retirement portfolio “pay cut.” Thinking ahead and taking small steps today can potentially make a big difference to you and your family tomorrow.