How to fund your early retirement with a 401k withdrawal plan or 401k and IRA withdrawal plan. You will also see why both the million dollar portfolio myth and 4 percent withdrawal myth exaggerate what it takes to retire.
Many people lose precious time continuing to work when they could be enjoying life on their own terms.
This is because of the "media message” about what it takes to retire early.
The messages of concern are "it takes more than $1 million to retire" and "you can’t withdraw more than 4% of your savings if you want your money to last through retirement."
Granted, health insurance is a huge expense without a job, but many people have this one covered by their retirement benefits from their employer or spouse’s employer after 20 or 30 years of service.
For those people, a comfortable retirement can be designed for much less than the "conventional" million dollars. Even if health insurance is not covered by an employer’s retirement plan, a healthy couple may be able to buy their own insurance and still retire for less than $1 million. It all depends on their lifestyle, retirement location, retirement age, and what they want out of retirement.
Consider this real people scenario:
In this real-life example, the monthly income comes from a monthly 401k withdrawal.
Even without considering investment gains, this income could be provided from 2 accounts with beginning balances of $288,000 and $230,000 from their retirement date until ages 65 and 67. Since these 401k accounts will continue to provide investment returns, it is very likely they will not be depleted by the time the couple reaches retirement age, so this is the worst case scenario: that the first 8-10 years of retirement income will cost $518,000.
If your 401k balance won't cover 10 years of withdrawals, it should at least cover your needs until age 59 1/2 when you can also take an IRA withdrawal without penalties, assuming you have an IRA, too. If your 401k doesn’t cover this time period, you could consider your non-retirement savings and plan to replenish them when you can take an IRA withdrawal without penalty.
The example couple's health insurance premiums are paid from their monthly income as part of their retirement budget, costing between $50 and $500 depending on the employer’s retiree benefits.
Later, if you want to provide additional money to supplement Social Security income, that could come from additional savings, which should be considerably less than the amount that covers the early retirement years. Let’s say you each want to have another $60-100,000, bringing the total savings needed to a maximum of $718,000. Still less than a million, right?
Extra vacation money, new cars, and major repairs may already be covered by the 401k withdrawals in the form of tax refunds. This is because of the mandatory 20% withholding that applies to 401k withdrawals. Since total income is low, a good portion of this tax will be refunded in the following year. A nice bonus for big ticket purchases.
Also, since the $718,000 remains invested, there will usually be gains that can be withdrawn for these special expenses, or to bump up withdrawals to cover their monthly payment.
Let’s consider the scenario where health insurance is not provided by an employer’s retiree benefit program. Even if this important coverage is to be paid out of pocket, an additional $120,000 should cover premiums of $1,000 per month for the 10 years before Medicare coverage begins. That will still be less than the $1 million dollar mark, at $838,000.
The big question is whether your lifestyle costs more than $3800 per month, for example. To be sure of this, you need to prepare a detailed budget that has been thoroughly brainstormed to cover all possible expenses.
Where to go from here: consult your fee-only financial advisor who can stress-test your retirement plan and tell you how likely your plan is to succeed.
Your advisor can run simulations against your portfolio to tell you how likely your money will last given your income needs. This will help you become comfortable with your retirement plan and help you fine-tune your goals.
The other popular recommendation that you should challenge is the 4 percent withdrawal rule. This rule cautions that you should not withdraw more than 4% per year if you want to preserve your retirement savings throughout your retirement.
Think about it this way: do you really need to leave millions of dollars to your heirs? If you withdraw only 4% and your investments earn 6, 7, or 8 percent OR MORE, your portfolio will continue to increase and become more valuable.
When you reach Social Security age, you may not even need 4 percent, especially since the 4 percent withdrawal should be higher each year. Are you working and saving to build up your bank account, never to be used, or are you working and saving so you can live a good life?
Using the numbers we came to in the previous example and a portfolio value of $718,000, you will be withdrawing roughly 8 percent. It is entirely possible that your portfolio could remain constant over your retirement if your returns are 8 percent or more.
Even if you lose ground, you are still likely to have a balance at the end of your life that you can pass on to your heirs.
This is something to consider as you plan for retirement.
How important is it to you to provide an inheritance to your children?
You should factor this into your retirement plans, if it is important to you.
Again, you should consult your fee-only financial advisor to discuss all of these topics and examine your specific plans and goals.