While I was browsing through the search terms that lead people to my blog, I noticed that “retire on 500K” came up more than once. Unfortunately it lead them to one of my past blog posts called Retiring on the One-Million Dollar Myth which doesn’t really specifically address the question (the post was more about reviewing what your individual needs during retirement will be).
Feeling a little bit guilty for not providing them with some definitive advice they could use, I decided to give them what they were looking for and start a fresh new blog post – this one!
While I am certainly NOT in any way a financial advisor (big disclaimer!), I’d still like to take a regular guy’s approach at answering the question of how to retire on 500K. I realize for many people that saving up $500,000 will not only be a huge challenge, but it will also be the reality of what their maximum nest egg size may grow to be. No matter what your situation is, I’d still like to help you by exploring the options and making the most of them.
Is It Really Possible to Retire on 500K?
I think the short answer is yes. But let’s be clear: It’s not going to be pretty or easy.
Although $500,000 isn’t an incredible amount of money, I think it is basically possible to retire on any dollar figure. You just have to know what you’d be getting yourself into first in terms of what you can afford and how long your money will last. As you can of course guess, a person who retires with 4-million dollars will have a much different experience that someone who decides to retire on 500K.
How We Won’t Retire on 500K:
I wish it was a few years ago (or even the 80’s) when interest rates were up. If they were, then this exercise would be really easy because all we’d have to do to retire on 500K is either buy a high yield fixed income annuity or a few long-term government bonds. Done!
But … that was then and this is now. Unfortunately interest rates are currently pretty pathetic; not to mention that both of these options will be chiseled away by income taxes. So we’ll have to try harder.
The 4 Percent Rule:
First things first, let’s assume that your 500K retirement money is safely stashed in a conservative tax-sheltered portfolio of low cost stock and bond funds that follow their respective Index funds. If we do this, then we know we have a good chance of making somewhere between 6 and 8 percent on average each year.
Following traditional advice and the safe retirement withdrawal 4 percent rule, we know that we should be able to pull out at least 4 percent each year with adjusts for inflation, and this should last us for about 30 years. However, 4 percent of 500K (the principal) is only $20,000 per year ($1,667 per month). For the best tax efficiency, we should have been keeping the money in a Roth IRA so we can avoid paying any future taxes once we start making withdrawals after age 59 and a half.
• Retire on 500K Result: $20,000 per year ($1,667 per month) with inflation adjustments and no income taxes due.
I don’t know about you, but that doesn’t sound so great! With such little money, I don’t want to run out. So let’s try something else.
A Roth Full of Dividend Stocks:
Is there a way we can retire on 500K without draining our principal? The answer is yes – dividend stocks. The great thing about taking only the dividend payments from your stocks is that it won’t matter what the value of the actual stocks are as the years go on. Think about it:
• Say your 500K is made up of 5,000 shares of stock at $100 each. A portfolio of 4% dividends would yield you $20,000.
• As long as you hold those 5,000 shares of stock and the dividend payment never gets cut, you should expect to get that $20,000 every year. All you need to do is pick good high quality dividend payers like from the Dividend Aristocrats or from the Dogs of the Dow.
• If the stock shares go down in value, then that’s okay. You still own 5,000 shares that pay that solid dividend of $20,000; so long as the dividend payment doesn’t get cut. (Technically, your dividend yield will just be higher. But that will be a moot point).
• If the stock shares go up, then that’s okay too. You’ll just continue to collect your $20,000 dividend payments and bank the rest. Hopefully, the dividend payments will rise and provide you with some type of buffer for inflation.
If you keep your money in just a regular broker account, then you can expect to pay taxes on the dividends you take out each year. So let’s avoid this!
To retire on 500K, let’s again use our Roth IRA to grow our dividend stocks and avoid paying any money on our withdrawals. The only trick is that we’ll have to wait until age 59 and a half.
In terms of inflation, strong dividend stocks should provide a natural buffer for inflation (as the price goes up, the dividend payment goes up). We could also rebalance our portfolio ever so often to capture lower prices / higher yeilds as another way to protect against inflation.
• Retire on 500K Result: $20,000 per year ($1,667 per month) with oppertunity for inflation adjustments and no income taxes due.
So now we have better stability to retire on 500K, but we’re still only making $20,000 per year. Can we do better?
Combine Withdrawals and Dividends to Retire on 500K:
Why can’t you have your cake and eat it too? As a compromise for income over safety, let’s use our dividend stock portfolio AND withdraw 1 percent from the principal balance each year. Initially, this will give us $20,000 plus $5,000.
This strategy is pretty straightforward at first, but it may get complicated as the future years go on. Going back to what I said about how it doesn’t matter the value of your stocks are because you’ll still get your dividend payment – that won’t be true if you cash in 1 percent of your shares each year. Example: If you cash out 1% of your stock shares for $5,000, you’ll reduce your dividend payments by 1% or $400. In terms of longevity, 1 percent is well below the conventional 4 percent rule, so your money still has pretty good probability of sticking around.
Once again: If we’re smart and use a Roth IRA to retire on 500K, we can avoid paying taxes on our withdrawals. Both of the arguements above still apply for inflation protection, but it will be a little more tricky with the combination of methods.
• Retire on 500K Result: $25,000 per year ($2,083 per month) with oppertunity for inflation adjustments and no income taxes due.
Without getting too risky, this is about as much as we can do with the principal balance. Luckily, we’ve got other money we can count on.
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Don’t Forget to Add Social Security to Our Retire on 500K Plan:
According to Social Security online, the average Social Security benefit is $1,230 per month. If we can wait until age 62 and add this to our Roth IRA plan above, then our prospects for monthly income will look much better:
• Retire on 500K Result: $39,760 per year ($3,313 per month) with oppertunity for inflation adjustments and income taxes paid only on the Social Security benefit.
Fortunately just like good quality dividends rising with inflation, we can also count on our Social Security benefit to rise with inflation as well due to a little thing called the Cost-of-Living Adjustment (COLA).
The only unfortunate thing about counting on Social Security is that for us younger people, after 2033, they think they will only be able to payout about 75% of what you should be getting. Therefore, that $1,230 might actually only be $923 each month. Hopefully our government is able to do something about this within the next +20 years.
Adding Additional Income Streams:
The real trick to any retirement plan, whether you retire on 500K or not, will be to supplement it with other forms of income. This opens up a whole other discussion about creating passive income streams.
Lots of people prefer to supplement their retirement with rental income from a series of rental properties. Some of us bloggers are trying to do it with blog income. There’s a ton of different ways and ideas for creating passive income. The point is that if you plan to retire on 500K, you should definitely have some sort of side income in motion.
Keep Your Expenses to a Minimum:
The secret to any financial situation is simply:
• Money In > Money Out
So to retire on 500K, we need to make sure that our expenses are kept to an absolute minimum. This will mean:
• Making sure your mortgage is paid off in full before you retire.
• Paying cash for a (used) car and not taking on any automobile payments.
• Not having credit card or student loan debt.
• Keeping all your regular expenses extremely (and sometimes creatively) low.
Retiring to Paradise:
Who says you have to retire on 500K in the United States or Canada? As you can guess, your dollar may stretch farther in a foreign country. Although I have no idea what the tax or safety implications would be for retiring to another country, there is certainly a growing trend of people who seem to be taking advantage of this opportunity. You can read about it often on the web and in magazine articles.
The Retire on 500K Summary:
Like I said – it may not be pretty. But lots of people have done it and made it work for them. There’s a blog and book about one gentlemen who was actually able to pull this off in his 30’s. The next time you’re at the book store, take a look at Early Retirement Extreme.
So while it may not be glamorous or jet-setting, I believe it is totally possible to retire on 500K. You may have to wait until your 60’s, get creative by adding some side income, and possibly cut your expenses down to the bone. But you do have options.
The important thing to take away from this exercise is that no matter what your nest egg size is, there are some strategies that have better safety and returns than others. I encourage you to explore them and make the most of what is available!
Readers – If someone asked you, do you think this is even possible? How would you answer the question of the best way to retire on 500K?
Photo Credit: Microsoft Clip Art, MMD