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 what kind of lifestyle you want, figure out what kind of income will support that spending, then build a savings and investment plan to reach those goals. That should be your retirement approach at age 25, 35 or 45.

In your 60's, 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. What kind of life can you live based on what you've saved up?

For example, say that you're an individual at age 65. You have $1.2 million in your pre-tax IRA and an expected $2,900 per month in Social Security benefits . What is your retirement budget?

Here are some things to consider. Otherwise, a financial advisor can help you build an effective retirement plan.

Income and Portfolio Management

First, you need to figure out what kind of income your savings can reliably generate. That will depend on a handful of circumstances.

Let's assume that you intend to retire at full retirement age of 67, to receive full Social Security benefits. That means you can start 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. Depending on market activity, at age 67 you might retire with:

• Corporate bonds, average return 5% – $1.32 million
• Mixed portfolio, average return 8% – $1.4 million
• S&P 500 index fund, average return 10% – $1.45 million

For the purposes of this article we'll assume middle of the road results and a retirement at age 67, so a $1.4 million IRA. From there, you could build a number of different income profiles. Three very different options might include:

1. 4% Withdrawals – Combined income $90,800
   At your most conservative, you might assume the 4% withdrawal strategy. Here, you invest for low-growth, high-security assets, withdrawing about 4% of inflation-adjusted income each year for 25 years. That 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 much higher security.
   
2. Aggressive market returns – Combined income $174,800
   Or you could go the opposite direction entirely. Let's say you invest the entire IRA in an S&P 500 fund and take out each year's returns as income. At the market's average 10% annual rate of return, that might give you about $140,000 per year of portfolio income for a combined income of $174,800.
   
   But that income would be 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 very good 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.
   
3. Annuity income – Combined income $147,180
   Annuities are contracts that promise you a fixed income for life in exchange for an up-front purchase price. They have significant upside, in that annuities can offer relatively high payments and 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, here a representative annuity might generate $112,380 per year for a combined income of $147,180 at age 67, but 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.

While a full discussion of the issue is beyond the scope of this article, 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 will 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.

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

With this approach, you would roll your entire pre-tax IRA into a post-tax Roth IRA. The advantage is that you would not pay taxes on any future gains or withdrawals from this portfolio, and you’d be able to avoid required minimum distributions (RMDs, more below). The disadvantage is that you would pay taxes on the entire value of the conversion at the time you made it, and you’d have to wait five years before withdrawing any gains without facing a penalty.

Required Minimum Distributions

If you don’t opt for a Roth conversion, your budget must account for required minimum distributions (RMDs). This is the amount that the IRS requires you to withdraw from any pre-tax portfolio each year starting at age 73. The 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. For example, say that you take the 4% withdrawal strategy. By age 73, your RMD requirement will likely be around $40,150 per year, significantly less than your planned withdrawals.

However it's important to at least be aware of this requirement. That's 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 strategy for your RMDs.

Long-Term Concerns

Finally, your budget should incorporate some of the long-term issues that retirees must anticipate. First, remember to budget for health care needs. While Medicare will pay for much of your health care, you should at least anticipate gap insurance and long-term care insurance to cover possible medical concerns that Medicare doesn't pay for.

Then there is inflation. At the Federal Reserve's benchmark 2% rate, a household can expect their 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, which often must be mixed 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 costs for renters have historically outpaced inflation by a fairly wide margin. Make sure your budget anticipates this.

A financial advisor can help you build a personalized retirement plan based on your specific circumstances. Get matched with a financial advisor for free.

The 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 On 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 up to three 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 — 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 .

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