For most people, retiring at 55 with $2.5 million saved is probably possible. However, the ultimate answer depends on the interaction of several factors, including your health, your anticipated lifestyle and spending in retirement, and how you invest your savings. Some factors, such as lifestyle choices or investment strategy, are predictable or controllable. Others, such as health and life expectancy, are less predictable or controllable.
A financial advisor can help you develop a workable retirement strategy.
Is it possible to retire at 55 with $2.5 million?
Retiring at age 55 with $2.5 million is entirely doable. That’s evident in the fact that that’s much more than the vast majority of people have when they stop working. According to the Federal Reserve’s Survey of Consumer Finances, only about one in 10 retirees has even $1 million saved. If more than 90 percent of people can retire with far less than $2.5 million, it’s likely that’s enough for you.
A $2.5 million nest egg could generate $100,000 in income per year if you tap your accounts at the oft-quoted sustainable withdrawal rate of 4%. This rule predicts that if you withdraw that percentage from your accounts each year, a nest egg will last for at least 30 years.
Is your income sufficient?
An annual income of $100,000 is well above the average salary of $60,944 earned by working people ages 55 to 64. And many retirement planners recommend using 70% of pre-retirement income as a starting point for budgeting for retirement expenses. 70% of $60,944 is $42,661. With that in mind, $100,000 a year is probably more than a reasonable income for a typical single retiree or even a married couple. Even assuming the 90% income replacement, which is at the high end of the range used by retirement planners, $100,000 isn’t far off.
Using the safe withdrawal rate is not the only strategy. Retirees can generate income by investing in fixed income, dividend-paying stocks and annuities. These income-focused investment strategies, pursued individually or in combination, can potentially yield 4% or more per year. If this approach is successful, a retiree can maintain their lifestyle without dipping into their basic nest egg, potentially allowing it to last indefinitely and leave a financial legacy to heirs or charity.
If you are ready to be matched with local advisors who can help you achieve your financial goals, get started now.
Accounting for taxes
Taxes are a difficult factor to predict, and their importance varies depending on where you live and your source of income. For example, eight states have no income tax and seven others do not tax retirement income.
California, the most populous state, taxes retiree income, including withdrawals from retirement accounts, as regular income. SmartAsset’s California retiree tax calculator shows that a single person born in 1968 will pay $5,520 in state income tax in California on $100,000 of taxable income.
Depending on the source of income, federal income tax may be another portion. For example, withdrawals from a Roth IRA are generally not subject to federal income tax. Capital gains and withdrawals from any type of retirement account are not subject to payroll taxes. However, withdrawals and capital gains of $100,000 may be subject to a long-term capital gains tax of 15% or $15,000.
In this simplified hypothetical example, the combined effect of state and federal taxes on a California retiree with retirement income of $100,000 would leave after-tax income of $79,480. Deductions and credits would likely adjust after-tax income upward for most retirees. The unadjusted remainder is well above the standard 70% income replacement for a single retiree, but could be well below the needs of a couple.
What could go wrong?
Healthcare costs are a factor that is difficult to quantify in advance and could potentially alter these results. A study by the Employee Benefits Research Institute found that a 65-year-old couple with typical prescription drug expenses would need $318,000 in savings to cover 90 percent of their healthcare costs in retirement.
If you set aside $338,000 of $2.5 million to cover health care costs, you can only withdraw $87,280 pre-tax with the remaining $2.182 million. And this hypothetical example doesn’t take into account health care costs from age 55 to 65. Since Medicare is only available at age 65, paying for health care costs over a decade with private health insurance or other means could significantly increase out-of-pocket costs beyond that amount.
The rules for withdrawals from tax-advantaged retirement accounts could also be a problem. Until age 59.5, most people must pay not only the income taxes due but also a 10% penalty on withdrawals from most types of accounts. This would reduce the purchasing power of your withdrawals until you reach the minimum age.
Inflation, another potential problem, reduces the purchasing power of a retiree’s income. For example, if inflation reaches the 2% target set by the Federal Reserve, it would reduce the purchasing power of $100,000 to $98,000 in the first year, $96,040 in the second, and so on.
However, this hypothetical inflation example does not take all factors into account. For example, interest rates often rise when inflation rises. This could cause the returns on a portfolio of interest-bearing investments to rise about as fast as inflation reduces purchasing power.
After all, age 62 is the youngest age at which most people become eligible for Social Security benefits. Social Security payments, which will average $1,827 a month in 2023, can go a long way toward covering living expenses in retirement. The need to wait for the certainty of those monthly Social Security checks is likely one of the main reasons more people don’t retire at 55.
Bottom line
A retirement account with $2.5 million will likely fund a secure retirement for most retirees. Whether it works for you will depend on how much you plan to spend in retirement, the investment strategy you choose, and a few important, less controllable factors, including future healthcare costs and overall life expectancy. But since that’s far more than most people have at any age, a nest egg of $2.5 million is a strong indicator that you can retire confidently at age 55.
Tips for retirement planning
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The combination of uncertainty about the future and a multitude of possible strategies can make it difficult to plan effectively for retirement without the help of a financial advisor. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview the advisors you find for free to help you decide which one is right for you. If you’re ready to find an advisor who can help you reach your financial goals, get started now.
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While you can’t know exactly what will happen between now and retirement, SmartAsset’s retirement calculator can help you make a reasonable projection. Enter your information, including where you live, income, the age you want to start claiming Social Security, current monthly savings amount, and other information. The calculator will tell you how much income you’ll likely need in retirement, how much Social Security will contribute, and how much you’ll need to have saved when you stop working.
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Have an emergency fund ready in case unexpected expenses arise. An emergency fund should be liquid – in an account that is not exposed to the risk of large fluctuations like the stock market. The downside is that the value of liquid cash can be eroded by inflation. However, a high-yield account allows you to earn compound interest. Compare savings accounts from these banks.
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The post “Can I retire at 55 with $2.5 million?” first appeared on the SmartAsset blog.