Ask an Advisor: Can We Afford to Retire When the Kids Turn 18? We Have $1.85M in Savings

My wife and I are 30 and 34. We have $950,000 in Roth IRAs, $900,000 in mutual funds and five-year CDs and we own our home worth $600,000. We have zero debt. I feel like we have to keep saving and investing to have a financially secure future, but my wife wants to live more in the moment and let our investments take care of themselves.

I have all our investments professionally managed and they all have done quite well over the years. We have four children and may have more but would like to stop working when the youngest graduates high school, in about 18 to 20 years from now. I make $220,000 a year and my wife currently stays home. She would like to go back to work eventually. I’m curious if we have the room to “live” more now or if my “keep-digging-in” approach is needed. Any advice would be appreciated. – Douglas

I think there’s a good chance you could afford to spend a little more now, depending on what your spending target is and how much you currently save. I’ll show you my reasoning so that you can decide if you’re comfortable with it.

If you need help planning and saving for retirement, connect with a financial advisor and see how they can potentially assist you.

There are a number of ways to approach this question, each with different starting points. I’ll walk through a simple approach to highlight the big picture before digging into the details.

How Much Will Your Investments Be Worth?

Let’s start by looking at your investments and projecting their future value. You have about $1.85 million saved between the Roth IRAs, mutual funds and certificates of deposit (CDs). We’ll need to estimate an investment return going forward. You should consider your own investment style and risk tolerance when making these projections, but let’s look at a few potential scenarios. After 20 years, your savings could grow to:

• $4,908,601 at 5% per year
• $7,158,916 at 7% per year
• $10,368,160 at 9% per year

This assumes you don’t contribute any additional savings, and only let your current investments grow at the estimated annual rate of return. (A financial advisor can help you make similar projections and estimate how much money you can afford to withdraw in retirement.)

Accounting for Inflation

We also want to consider the impact of inflation over such a long period of time. I think the easiest way to do that here is to adjust your savings balance. The values above reflect nominal dollars, but we can adjust them to reflect their “real” value after inflation.

Again, you’ll need to pick an inflation estimate. I suggest something around 3%. A simplified way of working that into your calculation is to subtract it from the nominal return rate. So, the inflation-adjusted “real” balances become:

• $2,749,003 at 5% (2% real)
• $4,053,578 at 7% (4% real)
• $5,933,201 at 9% (6% real)

Accounting for inflation in your projections enables you to determine the present value of your future balances, assuming your money grows at the nominal rate of return mentioned above. (Failing to account for inflation in your retirement plan can have drastic consequences, but a financial advisor can help you factor inflation and other risks into your plan.)

Assess Your Future Expenses

You also need to estimate how much money you’ll spend in retirement. Some expenses like healthcare may go up, but others (like feeding four kids) will go down. This is admittedly a little harder for you to estimate than someone who is older and closer to retirement.

Next, consider how much spending your savings can support. This requires you to decide how you’ll withdraw your money over time. There’s a lot to explore here and many options to consider, but again, we can start simply. The 4% rule provides a foundation, and we can use it as a basic estimate. If you aren’t familiar with withdrawal strategies, it may help to explore these different strategies.

In a nutshell, the 4% rule suggests that you can withdraw 4% of your savings (from a balanced portfolio) in your first year of retirement and then adjust your subsequent withdrawals for inflation each year going forward. This basic rule of thumb is designed to help retirees stretch their savings at least 30 years. (A financial advisor can help you devise a withdrawal strategy and income plan for retirement.)

Checking Your Numbers

Let’s stop here to do a high-level check to see how much income your portfolio may generate if you follow the 4% rule using the projections above:

• 5% annual rate of return (2% real): $109,960 in annual portfolio income
• 7% annual rate of return (4% real): $164,143 in annual portfolio income
• 9% annual rate of return (6% real): $237,328 in annual portfolio income

Because these amounts are taken from your inflation-adjusted real balances, you can directly compare those against your spending target in today’s dollars. One thing that really sticks out to me here is that the last income estimate is higher than your current total gross income, and I’m betting you don’t spend anywhere near all of that.

Don’t Forget About Taxes

Although you’ll be under 59 ½ years old if you retire in 20 years, you can make tax-free withdrawals from your Roth principal (but not investment earnings). Your taxable investments, if managed correctly, may produce primarily long-term capital gains that also get more favorable tax treatment than ordinary income.

The result is that your retirement withdrawals are likely to be much more tax-efficient than your current income, meaning you’ll pay less in taxes on that money. This is worth examining more closely. Talk to your advisor or tax professional to get a better understanding of the tax implications so that you can compare your current net spending with your future net spending. (If you need help finding financial advice, consider connecting with a financial advisor using this free matching tool.)

Thinking about working with a financial advisor? Try the calculator below to see how an advisor could impact your finances.

Next Steps

I don’t know how much of your current income you save or how much income you feel like you need to replace to retire comfortably. But I do see that at least one reasonable estimate puts you in a position to have a higher level of income, with a lower tax bill, than you have now. Most people in this position are in very good shape. And, we didn’t even consider Social Security or your wife’s earnings if she does go back to work.

It also doesn’t have to be an all or nothing approach. Here, we assume you don’t save any additional money. But it may just be that you save a little less than what you currently do. Hypothetically, let’s say you currently save $24,000 a year. Maybe you and your wife split the difference and you save $12,000 but then spend the other $12,000. You’ll need to decide on an approach that each of you is comfortable with, but this analysis should help you get started putting everything into context.

Retirement Planning Tips

• If you have money saved in pre-tax retirement accounts like traditional IRAs and 401(k)s, you’ll want to plan for required minimum distributions (RMDs). These mandatory withdrawals start at age 73 (age 75 for people who turn 74 after Dec. 31, 2032). Failing to take the correct RMD can result in tax penalties. SmartAsset’s RMD calculator can help you estimate how much your first or next RMD may be worth.
• A financial advisor can be a valuable resource for people who are planning their retirement. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Emergency savings are important, even for retirees. Maintain an emergency fund with enough money to cover between three and six months worth of living expenses. An emergency fund should be liquid; kept in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.

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