Unfortunately, not all of us are great savers. Most financial articles will recommend that you’ll need at least $1 to $2 million dollars in savings before you can even consider retirement.
But the reality for a large segment of the population is anything from that. To give you an idea, a 2015 study from the Government Accountability Office found that those savers between the ages of 55 to 64 have an average of just $104,000 in their retirement accounts.
This is not surprising at all.
With the responsibility of saving for retirement having shifted from company-sponsored pensions to individuals, the shocking truth for many people will soon be “whatever you have saved is all there is”.
Even though the easy answer is to simply continuing working full-time, sometimes “life” has other plans for you. Health issues, taking care of spouses, job elimination, and dozens of other challenges may force you to consider retirement earlier than you may have previously planned.
Therefore, the question remains: If you’re in your 50’s or 60’s and short on retirement savings, how do we make the most of it? How can we stretch those dollars to give you the best and most reliable outcome possible?
In this post, we’re going to thoroughly explore your options and see how we can retire on a $500,000 nest egg. (Note that you can still follow along and re-work the examples if you’ve got other levels of savings. The logic behind the strategies will still apply.)
1- Lifestyle Moderation
First things first, if you’re going to have any chance of success with retiring on just $500K, then you’re going to need to really concentrate on making some lifestyle changes. Mainly: Exercising a strong sense of moderation when it comes to your spending.
Let me be blunt: Nothing in the strategies we’re going to suggest will produce anything close to the type of glamorous lifestyle, you might see in magazines or the latest episode of Beach Front Living. These things portray lifestyles that a majority of the population will unfortunately never achieve. So do yourself a favor – ignore them.
Those people who have retired on less than $1 million have been able to do so because they learned how to budget and become very careful with their spending. Just like someone who is on a diet and counting every calorie, they applied this same line of thinking to their finances and will make every dollar count as well.
While moderating your lifestyle will be an incredibly important part to retiring on $500K with success, we will not spend too much more time on it here. We’ve got plenty of other articles that talk about how to achieve a frugal lifestyle. In fact, we even started a whole separate website called 1,000 Ways to Save which is designed to help people get maximum amount of spending power at a minimal price. Please do check it out.
For the rest of the article, we’re going to instead focus on the more technical part of determining just how much money we can expect to produce at this savings level.
2- Starting With The 4 Percent Rule
The first thing we need to be concerned with here is “safety”. How much money from our $500,000 retirement savings can we safely withdraw without fear of running out of money and having to return to work full time?
To answer this, the first thing that we can look at is something called the 4 Percent Rule. The 4 Percent Rule comes from a study that was conducted from a financial adviser named Bill Bengen to determine what the optimal safe withdrawal rate should be. His conclusion was that a retiree could reliably withdraw 4 percent of their initial nest balance for at least 30 years with inflation adjustments.
To put this into context, if we have a portfolio of $500,000, this means we can safely withdraw $20,000 per year ($1,667 per month). Then the following year, you could adjust for inflation (say 3%) to $20,600, regardless of what your portfolio value is. And so on.
(For more information, you can read a very exhaustive article we put together called “The 4 Percent Rule – Everything You’ve Ever Wanted to Know”.)
The Age 59-1/2 Rule
Most traditional 401(k) and IRA accounts will impose a 10% penalty on any withdrawals made before this age.
However, you should know that you’re not necessarily “stuck”. I’ve written an entire ebook on several strategies you can use to get your money out. It’s called “How to Unlock Your Savings Before Age 59-1/2 Without Penalty”, and I guarantee you’ll find plenty of useful tips in there.
Please note that for the 4 Percent Rule, it is always assumed that your withdrawals are taken pre-tax. This means you will still need to pay taxes on this money.
However, you can easily side-step this problem if you can find a way to save or convert your retirement savings into a Roth IRA. Remember that with a Roth IRA, all of your contributions are available tax-free and penalty-free. The capital gains portion is also available tax and penalty-free, but not until after age 59-1/2.
3- Don’t Forget About Social Security
Social Security is something that a lot of U.S. tax-payers forget about when it comes to retirement planning. But if you plan to retire on $500K, you are going to want to make sure you get every penny you’re entitled to.
You can determine how much money you’re scheduled to receive by going to Social Security’s website and logging into your account. According to their figures, the average payout is approximately $1,341 per month or $16,092 per year. Of course this amount will vary depending on how long you’ve worked and how much you’ve earned over the years.
Generally speaking, you can start collecting your Social Security benefits starting at age 62. Therefore, depending on how old you are now and how much money you’ll need, you may want to gauge your retirement date around this criteria. It could mean yet another reliable income stream for you.
Combining the average reported Social Security monthly benefit with withdrawals from our nest egg savings example, this means you could be looking at:
$1,667 + $1,341 = $3,008 of total income per month (or $36,092 per year total).
Double-Down with a Spouse
Don’t forget: If you’ve got a spouse who has also worked and paid into the Social Security program, then you’re both eligible to receive benefits. So be sure to check into each individual’s account.
Got a While Until Social Security?
Is your plan to retire in your early 50’s, and therefore it will be a while until you are in your 60’s and can start receiving Social Security? If so, no problem. We did a study to see how much higher of a safe withdrawal rate you could start with at a younger age if you expected to start receiving Social Security later on. On average, the future benefit added approximately 0.5% in the near term. Click here to read the full study.
4- How to Increase Your Safe Withdrawal Rate
How long do you need the money?
First of all, remember that we said the “4 Percent” figure is tied to a period of 30 years. According to another famous paper on safe withdrawal rates known as the Trinity Study, if you only need your nest egg to last for a shorter time period (perhaps thanks to an upcoming annuity, pension, or some other delayed income stream), then you should be able to use a higher rate. For example, a portfolio with a 5% withdrawal rate for 20 years would have almost the same probability for success as one with a 4% withdrawal rate for 30 years (94% vs 96%).
(Alternatively, if you’re much younger and want your money to last for 50 years or more, than you might have to go with a lower rate such as 3.5%.)
Playing the Probabilities
In the original paper about the 4 Percent Rule, the author had determined that in the worst of economic conditions this safe withdrawal rate would last for a minimum period of 33 years.
However, there were many periods throughout history where higher safe withdrawal rates ended up working out just fine. The problem is that no one knows when those safer periods are going to happen. Therefore, this becomes a question of probability: What kind of odds do you need to feel safe? 100%? 90%? 85%?
Technically, you can increase your withdrawal rate to any number you want. But of course the higher up you go, the more your odds of success decrease, and the greater your chances of running out of money increase. Again, we can refer to the Trinity Study to see what kind of probabilities they predict. Or you can easily estimate this for yourself by playing around with an online calculator called FIRECalc.
Using the Shiller CAPE to Safely Gauge a Higher Withdrawal Rate
So how can you predict when a higher safe withdrawal rate might be okay to use?
An economic value known as the Shiller CAPE can be used to gauge whether the market is over or under-valued. It’s been shown that this factor correlates to market returns over the next 15 years, and this can help us determine whether or not higher withdrawal rates may be safe.
In a famous paper from financial researcher Michael Kitces, it was found that the safe withdrawal rate could be adjusted as high as 5.5% when the Shiller CAPE was equal to 12 or below.
Combining This All Together
Taking everything we’ve said in this section into account, if we can squeak out another 1.0% on top of our previous safe withdrawal rate, then this will yield another $5,000 of additional income per year.
This brings our annual total income up to $41,092, or $3,424 per month.
5- Reducing Inflation Adjustment to Get More Up-Front
One aspect of the 4 Percent Rule as well as many other safe withdrawal rate studies is that they all mostly assume that you will compensate for inflation each year. In other words, you’ll add about 3% to the prior year so that your money maintains the same amount of purchasing power.
However, if you were to delay or even reduce the amount your inflation adjustment, this could allow you to start the whole process using a higher rate.
How much higher are we talking?
If we again refer to famous Trinity Study, it was shown that when the retiree makes absolutely no inflation adjustments at all, they could actually start off their retirement withdrawing as much as 7 percent! Now while that may not be practical (and I certainly wouldn’t recommend it), the idea does give you some indication of how this strategy could work to your benefit. Adjustments to your inflation rate could alter your withdrawal rate somewhere between 4 and 7 percent.
To more accurately quantify the situation, I did my own analysis and was able to demonstrate how something as simple as reducing your inflation rate by 1.5% per year would allow you to start your retirement with a safe withdrawal rate that is 0.5% higher than what you would have normally started with.
Lots of Us Already Don’t Adjust for Inflation
While you will certainly have to make some adjustments to your income over time to account for inflation, this may not necessarily have to happen every year or to the same degree as most financial planners would recommend. Think about how many times you or people you know may not get a raise this year (or several years in a row). But we don’t go bankrupt. We find ways to adjust and make due.
Assuming this strategy allows us to yield yet another 0.5% on top of our previous example, then this will yield another $2,500 of additional income per year.
This brings our annual total income up to $43,592, or $3,633 per month.
4-5 Alternative Strategy – Dividend Income
If our suggestion in Tips 4 and 5 of playing the odds with different withdrawal rates seems too risky, or if you’d like to seek a potentially higher rate of return, then I will introduce you to an alternative strategy: Generating income using dividend paying stocks.
Dividends are the payments you receive as the owner of stocks from certain companies; usually from their profits. Thousands of companies offer them. Generally, as a shareholder, you will be paid on a quarterly basis. These payments can be any domination and are always subject to change.
One very popular retirement income strategy is to build up an entire portfolio of dividend paying stocks and then live off of the payments they generate. You literally don’t have to do anything except be a shareholder of the stocks.
Where to Look
Even though the stock market as a whole tends to pay an average of around 2 percent, it is possible to build a portfolio that pays around 4 percent per year. Two places you could start looking would be The Dogs of the Dow and The Dividend Aristocrats.
Often times too you’ll see magazine articles or blog posts claiming to teach you how to pick dividend paying stocks that pay an average of 5 percent or more. However, be careful! The higher the dividends you’re after, the more complicated it will be to deliver consistent results. If you’ve never purchased or traded individual stocks in the past, you might want to consult a professional first.
Pros & Cons
As with any strategy, there will be pros and cons to it.
One of the best parts about it is that you never have to touch the principal investment (in theory). You will only live off of the dividends. So no matter what happens to the stock market or what price they fluctuate to, it will not matter as long as the dividend payments continue to roll in.
However, in practicality, you won’t necessarily want to cut yourself off from the principal completely. If an emergency were to occur (… and one always does …) and you needed to sell your stocks, the last place you’d want them to be is down in price.
Furthermore, it is never recommended that a retiree holds their entire nest egg in 100% equities. The fluctuations you might experience in portfolio value might be way outside your personal tolerance for risk.
For the dividends themselves, there is also no guarantee that the stock will continue to pay at the same level or higher for forever. Though some companies have a much better track record than others, this is still no promise.
Also, beware of chasing after dividend yields that seem too good to be true. For example, there are stocks out there that pay 10% dividend yields. But that doesn’t mean the stock is necessarily any good or that they company will continue to pay at this level forever. Make sure that you only invest in strong, reputable companies that will continue to produce results.
6- Part-Time Income
For example, if you have any talent at writing, you could easily earn $1,000 per month by picking up a few assignments at $50 to $100 each from any number of online job boards. The great thing about this particular example would be the flexibility that it would provide. You could choose when and where to work, and complete them at your leisure.
Of course there are hundreds of examples we could through: Consulting, sales, teaching, coaching, photography, graphic arts, crafting, … and many, many more.
A Little Work Might Be Good For You
Though the idea of going back to work, even for just a little bit, might not sound appealing, there is a psychological factor that you may be underestimating. One of the biggest complaints retirees have is that quite frankly: They get bored.
They suddenly have all of this new found time on their hands and they have no idea how to fill it. In attempt to find some semblance of purpose or even just to be social, they gladly welcome the opportunity to take on a new part-time job – perhaps doing something that they’ve always had as an interest or hobby.
Suppose we assume you are able to find a part-time gig generating an extra $1,000 per month. This brings our example up to $55,592 per year or $4,633 per month.
7- Tapping Your Home Equity
Downsize / Relocate
The first would be sell your house out-right. By selling your house and moving to a smaller one and/or relocating to a lower cost of living area, you could unlock your home’s value and add it to your nest egg.
The good news too is that for many middle class Americans the profit from the sale of a home (up to $500,000 for married couples) is tax-free.
This has been a strategy used by many retirees, including one of my favorite early retirement success stories, “The Charltons”. In their awesome ebook “How to Retire Early”, they talk about how they were able to generate $300,000 in equity from the sale of the home which in turn helped them to retire in their 40’s.
If you like your home but would rather not move, another option on the table would be to use a reverse mortgage.
Okay … so I know reverse mortgages often get a bad rap. But to be fair: Just like any financial product out there, I’m sure there are lots of legitimate options available.
The way a reverse mortgage works is that the lender gives the home-owner a pre-determined amount of money (usually some percentage of the value of the home). When the owner moves, dies, or the lending term ends, the owner then has to pay the lender back.
According to a very detailed calculator provided by retirement researcher Wade Pfau, a $200,000 house may be able to yield as much as $776 per month ($9,312 per year) in extra revenue.
This brings our cumulative example up to $64,904 per year or $5,409 per month.
Keep in mind that if you are considering this option, you must first be 62 years or older to apply. Also your home should be paid off or nearly paid off.
Though a retirement based on $500K may not be very luxurious, given the current state of retirement savings in the U.S., it may become a forced reality for those who have little options. Therefore, we need to have strategies for stretching our dollars as far and safely as possible. By exercising lifestyle moderation, sticking to a budget, and staying within the confines of the tips we’ve explored here, then you’ll be putting yourself in the best possible position for success.
If you’re still a little ways away from retirement and have more time to save, then I encourage you to check out my ebook “Save Better!“. In this book, I’ll teach you exactly what tools to use to make the most of your savings, avoid taxes, and maximize your returns.
Readers – What do you think? For those people in their 50’s and 60’s who may be forced into retirement, what advice can we offer them? How can someone retire on $500K while striking a balance between safety and comfort?