I’m 65 With $1.2 Million in an IRA. I’ll Get a $2,900 Monthly Social Security Benefit. What’s My Retirement Budget?

As you approach retirement, your financial focus shifts. During your working life, retirement is about goals and planning. You decide the lifestyle you want, and determine what income will support it, then build a savings and investment plan to reach those goals. In your 60s, though, the accumulation stage is largely over. You have your retirement portfolio in place, with some room left for growth, and now it’s about managing and budgeting that wealth. For a 65-year-old with $1.2 million in an IRA and $2,900 in monthly Social Security, this is the kind of retirement budget you will need for the quality of life you want.

A financial advisor can help you build an effective retirement plan based on your long-term financial and retirement goals.

Income and Portfolio Management

First, you must determine what kind of income your savings can reliably generate. This will depend on a handful of circumstances. 

Let’s assume that you intend to retire at full retirement age of 67 and receive full Social Security benefits. That means you can begin with an expected $34,800 per year of income ($2,900 * 12). 

It also means that you can plan for two more years of growth in your IRA.

The exact numbers will depend entirely on your investment strategy, but let’s say that you have your entire IRA invested in one of three benchmarks: corporate bonds, a mixed portfolio and an S&P 500 index fund.

Assume you invest in a mixed portfolio earning an 8% return annually between now and age 67. As a result, your IRA would grow to $1.4 million within two years.

From there, you can build a number of different income profiles, including these.

4% Withdrawal: Combined Income of $90,800

At your most conservative, you might assume the 4% withdrawal strategy. Here, you invest in low-growth, high-security assets, withdrawing about 4% of inflation-adjusted income each year for 25 years.

This could give you about $56,000 per year from your IRA ($1.4 million * 0.04). With Social Security, you can expect about $90,800 of inflation-adjusted combined income. This is relatively low-growth, but provides much higher security.

Aggressive Market Returns: Combined Income of $174,800

You can also go the opposite direction and invest the entire IRA in an S&P 500 fund. You then withdraw each year’s returns as income. At the market’s long-term average annual rate of return of 10%, this could give you about $140,000 per year of portfolio income for a combined income of $174,800. 

However, this income is incredibly volatile. Most years, you will collect either significantly more, significantly less or nothing at all. This is an unpredictable approach to retirement.

Without a reliable plan to manage the down years, you can easily find yourself spending a year living off Social Security alone while waiting out a bear market. 

Annuity Income: Combined Income of $153,800

Annuities are contracts that promise a fixed income for life in exchange for an upfront investment.

Annuities have significant advantages, offering relatively high payments with significant security. The major downside is that they generally do not adjust for inflation. Over a long retirement, the value of that contract can drop by as much as half.

For example, an annuity may generate approximately $119,000 per year for a combined income of $153,800 at age 67. However, only the Social Security payments would be inflation-indexed.

A financial advisor can help you make projections for various scenarios and weigh your options for retirement income.

Tax Management

Since you have an IRA, all of your income calculations will be pre-tax. This will involve two tax rates: income taxes and Social Security benefit taxes.

Social Security benefits are taxable based on your total income. In this case, you will likely add about 85% of your benefits ($29,580) to your taxable income and not pay taxes on the remaining 15% ($5,220).

Beyond that, any income from your IRA-based portfolio will be taxed at the rate of ordinary income. However, you will only pay income taxes, not FICA taxes.

Roth Conversion

As an alternative, you could plan for a Roth IRA conversion.

With this approach, you roll your entire pre-tax IRA into a post-tax Roth IRA. The advantage is that you do not pay taxes on any future gains or withdrawals from this portfolio. You can also avoid the required minimum distributions (RMDs).

The disadvantage is that you will pay taxes on the entire value of the conversion when you make it. You will then have to wait five years before you can withdraw any gains without penalty.

Required Minimum Distributions

If you skip the Roth conversion, your budget must account for required minimum distributions (RMDs).

The IRS requires these annual withdrawals from any pre-tax portfolio starting at age 73. The RMD amount is based on your current age and your portfolio’s value. 

Many households will never have to actively plan for RMD requirements, since they are often less than the typical individual’s income needs. To calculate your RMD, take your IRA balance on Dec. 31 of the year before you reach age 73 and divide by the IRS Life Expectancy Factor for age 73 (26.5). This is the amount you must withdraw from your account.

However, it’s important to be aware of this requirement in case. This is particularly true for households with multiple retirement portfolios, since you cannot simply spend one down and leave the other in place.

A financial advisor can help you determine the most tax-effective RMD strategy.

Long-Term Concerns

Finally, your budget should incorporate some of the long-term issues that retirees must anticipate.

First, remember to budget for healthcare costs. While Medicare will pay for much of your health care, you should at least anticipate gap insurance and long-term care insurance for possible medical concerns that Medicare doesn’t cover.

Then there is inflation. At the Federal Reserve’s benchmark 2% rate, a household can expect its spending power to halve roughly every 30 to 35 years.

As retirements get longer, you can start pushing that boundary, so make sure your retirement budget anticipates inflation. This is particularly true for the high-security, low-growth assets common to a retiree’s portfolio. It is wise to mix these investments with at least some growth-oriented assets to properly adjust for inflation.

This is a particularly urgent issue for households in high-cost areas. While 2% is the benchmark inflation rate, costs increase much more quickly in urban areas and other expensive communities. If you rent, in particular, be aware that renter costs have historically outpaced inflation by a fairly wide margin. Make sure your budget anticipates this.

Retirement has a lot of long-term financial considerations. See if you’re on track for what you need:

How to Sequence Withdrawals in the First Decade of Retirement

Which accounts you pull from and in what order can matter as much as how much you withdraw.

A $1.4 million pre-tax IRA and Social Security benefits give you a workable retirement income. However, the sequence of your withdrawals over the first ten years will shape both your tax burden and the longevity of your portfolio. Getting this right early creates compounding benefits, but getting it wrong is difficult to undo.

The two years between the ages of 65 and 67, before Social Security begins, represent a window worth noting. With no Social Security income, your taxable income during those years could be unusually low.

That makes it an efficient time to convert portions of your traditional IRA to a Roth. You will pay taxes at a lower rate than what you’ll face once Social Security and required minimum distributions kick in. Every dollar you convert now is a dollar that grows tax-free and is not subject to RMDs later.

Sequence-of-Returns Risk

Sequence-of-returns risk is the other reason the early years matter disproportionately. If the market drops 20% in your first or second year of retirement while you’re making withdrawals, those losses are locked in permanently. The portfolio has less capital left to recover, and continued withdrawals accelerate the decline.

A bear market in year 15 is far less damaging than the same bear market in year two, because by then you’ve already drawn down a significant portion of the balance. It’s the primary reason otherwise sound withdrawal rates fail in historical backtesting.

One practical way to manage this risk is to set aside one to two years of living expenses in a high-yield savings account or a money market fund before you retire. If the market drops early in your retirement, you draw from the cash buffer instead of selling equities at a loss.

This gives your portfolio time to recover without the added pressure of funding your daily expenses. Once the market stabilizes, you replenish the buffer from portfolio gains. It’s a simple mechanism, but it addresses the single largest threat to a portfolio’s longevity in the early years.

Asset Allocation

As you move through the first decade, the mix of your portfolio should also shift. A 65-year-old with a 30-year time horizon still needs growth, but the proportion of stable income-producing assets should increase as the portfolio draws down. Gradually moving from equities toward bonds, dividend-paying funds or other lower-volatility holdings reduces exposure to sharp market swings that are hardest to absorb when you’re no longer adding new money.

The goal isn’t to eliminate risk entirely. It is to align the portfolio’s behavior with your shrinking time horizon and increasing reliance on what it produces.

Bottom Line

For an individual with $1.2 million in an IRA by age 65, your retirement budget can be relatively comfortable. While this will require careful tax and investment management, this profile could have several options.

Tips for Managing Inflation

• Inflation is one of the sneakiest pitfalls in retirement investing. If you’ve ever seen someone grumble about how little things used to cost back in their day, you’re seeing the inflation trap at work. So let’s help you build a retirement plan around it. 
• A financial advisor can help you build a comprehensive retirement plan. 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.
• Keep an emergency fund on hand in case you run into unexpected 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.

Photo credit: ©iStock.com/Goodboy Picture Company