The past year was a good year for stocks, with the S&P 500 growing 25% in 2023.
In fact, you may have noticed that your retirement savings have grown substantially this year and are wondering whether you can retire now.
Before rushing into it, make sure you’re ready. The main question you face in your decision to retire is whether you have adequate savings to cover your expenses throughout retirement. Your money may need to last for decades.
The more you have saved, the better the odds are that you’ll be successful. But don’t neglect careful planning.
[What Is the Average Retirement Savings Balance by Age?]
Consider Sequence of Returns Risk
If you are thinking about retiring soon, the strong stock market in 2023 is certainly good news. Not only did it push your portfolio higher, but the timing was fortunate, too.
That’s because the returns your portfolio earns toward the end of your career and into the early years of retirement have an outsized effect on how long your savings might last.
Bad returns during these early years can create real strain. But if your portfolio grows through those first few years of retirement, it can significantly reduce the chances that you run out of money later.
This is called the sequence of returns risk. It refers to the risk that you experience poor returns early in retirement.
Note that I’m not talking about average returns but the specific sequence in which those returns come.
Consider the following two hypothetical series of annual returns:
| Retirement Year | Scenario 1: Portfolio Return | Scenario 2: Portfolio Return | Withdrawal (full distribution is taken on the first day of the year) |
| Year 1 | 22% | -15% | $50,000 |
| Year 2 | 15% | -10% | $50,000 |
| Year 3 | 6% | 6% | $50,000 |
| Year 4 | -10% | 15% | $50,000 |
| Year 5 | -15% | 22% | $50,000 |
| Average Return | 3.6% | 3.6% | — |
| Value of portfolio after five years | $1,739,979 | $375,045 | — |
Those returns are the same numbers, just in reverse order.
They have the same arithmetic average. But the first example is much better for a recent retiree. At the end of five years, their portfolio has grown. In the second example, the portfolio has lost significant value.
Experiencing those positive returns early in retirement has a lasting, positive impact on a retiree’s savings. So, retiring when the market is up can be a savvy move.
[READ: How to Retire With $250K in Savings]
How Much Money Do I Need to Retire?
You shouldn’t retire just because your portfolio had a good year. You need to be reasonably confident that your retirement savings are adequate, whether the market is good or bad. So how do you do that?
Estimate Your Expenses and Income Needs
Start by estimating the expenses you’ll have in retirement based on your budget. Then subtract any guaranteed income you may receive. Common income examples are Social Security, pensions or annuities. If you plan to work part-time, you can factor that in as well. The remainder is what you’ll need to pull from savings.
To see this with some simple numbers: Assume you’ll need $80,000 per year and plan to collect $30,000 from Social Security. That means you’ll need to cover the remaining $50,000 with savings.
Compare Your Planned Distributions to Your Savings Balance
To quantify your question, compare your planned withdrawals to your savings balance. You may find it helpful to think about it in terms of a withdrawal rate, or the percentage of your balance that you’d need to withdraw each year to support yourself.
Don’t Forget About Taxes
Think about how taxes affect you because it will matter. Keep these rules of thumb in mind:
— Withdrawals from tax-deferred accounts are taxed as income at your marginal rate.
— Qualified distributions from Roth accounts are tax-free.
— If you sell investments in taxable brokerage accounts to withdraw money, you’ll have to consider capital gains.
To simplify the example here, let’s assume your entire savings balance is held in Roth accounts. This isn’t a realistic assumption for most people, but it will let us move forward without overcomplicating the discussion.
Consider Your Withdrawal Rate
To find your withdrawal rare, simply divide your expected annual withdrawals by your portfolio balance. Here, we have assumed we will withdraw $50,000. If your savings balance is $500,000, then your withdrawal rate is 10%. On a $1 million balance, your withdrawal rate is 5%.
You’ll want to spend some time researching and deciding on a withdrawal rate you’re comfortable with. There is no one-size-fits-all rate that is right for everyone.
If you’re new to the idea of retirement withdrawal rates, try starting with the 4% rule. It may not be right for you, but start by reading about it to learn how withdrawal rate planning works. You may find the 4% rule to be a good fit or you may decide to modify it to fit your situation better.
Remember Your Other Expenses
Your regularly budgeted expenses aren’t the only expenses to consider either. Plan for long-term care costs, gifts to family such as a grandkid’s college fund or bequest goals. It may be that you set a certain amount of money aside for these items.
[What Is the Outlook for Retirement in 2024?]
Should You Retire Just Because Your Investment Accounts Are Up?
Strong investment returns and a growing savings balance provide a good push leading into retirement. But you shouldn’t solely rely on recent trends in your investment portfolio and a larger savings balance to get you through.
Think about the expenses you’ll have in retirement and consider the resources you have to cover them. Develop a plan you are comfortable with — and retire when you are confident you are ready.
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Ask a Financial Pro: My Retirement Savings Are Up. Should I Retire This Year? originally appeared on usnews.com
