teegardin / Flickr
A Reddit user is wondering if a $2.5 million nest egg can produce $100K in income.
He’s concerned about taxes but also needs to pay attention to his withdrawal rate.
If he wants to avoid worrying about taxes as a retiree, he can save in Roth accounts.
A recent study identified one single habit that doubled Americans’ retirement savings and moved retirement from dream, to reality. Read more here.
When you are making plans for retirement spending, you need to take many costs into account — including taxes. If you are hoping that $2.5 million will provide you with $100K, you should consider both whether that income is possible at a safe withdrawal rate and how your tax bill is going to affect the amount you have left over to spend.
Before you even consider the impact of taxes, you need to make a decision on a safe withdrawal rate.
Experts traditionally recommended that you follow the 4% rule if you wanted the best chance of your money lasting for at least 30 years. Since that rule says you can withdraw 4% of your account balance in your first year of retirement and then make inflation-based adjustments, your $2.5 million could produce exactly $100,000.
However, experts have now revised that downward to say you should limit withdrawals to 3.7%. There have also long been questions as to whether the 4% rule is conservative enough, especially as projections for future returns have gotten lower and projected future lifespans have gotten longer.
If you don’t mind taking a greater chance of your money running short, you could still stick with the 4.00% rule and assume you’ll be able to withdraw $100K from your $2.5 million account without problems. But, if you don’t like the idea of cutting things so close, you may be better off aiming to save a little more to give you a cushion — even before you consider the issue of how taxes will impact your ability to spend $100K.
Thinkstock
Now, you have another issue to deal with: Taxes. Let’s say you do decide you’re OK with taking $100K per year out of your accounts. The question becomes, how much of that money will you have to give to the IRS and to your state or local government? If you were hoping to have $100K after taxes to spend, will that be possible?
The answer to that is: It depends. If you have put all of your money into a Roth IRA or Roth 401(k) account, then you don’t have to worry about taxes as long as you follow the rules for tax-free withdrawals. If you take $100K out, you can spend it all. If you want to take the simplest approach and not have to think about the impact of taxes on your investments, this is most likely the route you should go.