Can I Afford to Retire?

Mark just got home from his coworker’s retirement party. Some thoughts loomed: “When should I retire? Could it be sooner? Am I ready? Can I afford it? What will I even do?” Lisa, Mark’s beloved, long-time, amazing wife, had been running the numbers in her head for years. The closer retirement got, the more real those questions felt. They needed a concrete next step.

Mark and Lisa are a hypothetical couple, both 62. The five steps below are how I would help them think through a retirement decision: organize, establish a vision, map the cash flow, check the key numbers, and test what could change.

Step 1: Organize

Getting organized comes first. To see why, put yourself in Mark and Lisa’s shoes. They have many questions and are in a state of angst (sorry, Mark and Lisa, that is how I am writing this, and I have determined that you are antsy). Setting goals before the more pressing facts are in would be premature. Financial planner Michael Kitces makes a similar point: you can’t decide where you’d like to go until you know where it’s possible to go [1].

Not everything needs organizing at once. Because their question is about retirement, the first things to gather are the ones that answer it: family, assets, debts, income, savings, and expenses. Wills, trusts, and tax returns can wait. They matter, but they don’t get at the core question: can Mark and Lisa afford to retire?

In practice, that means every account, loan, source of income, and regular expense, including Social Security estimates from a my Social Security account. Goals come next, in Step 2.

Here is what Mark and Lisa wrote down:

• Family. Mark and Lisa, both 62 and both still working, with two grown children and three grandchildren.
• Assets. About $1.47 million in five kinds of accounts: $950,000 in pre-tax 401(k)s and IRAs, $150,000 in Roth IRAs, $250,000 in a joint taxable account (about $150,000 of it money they put in), an $80,000 cash reserve and $40,000 in Mark’s health savings account (HSA). A paid-off home worth about $400,000; its property tax and insurance are part of living costs.
• Debts. None beyond a credit card they pay in full each month.
• Income. Two salaries until they retire. Social Security at 67, their full retirement age: estimates of $2,500 a month for Mark and $1,500 for Lisa. Those estimates are in today’s dollars, and benefits rise with inflation, so by 67 they come to about $54,300 a year together. Lisa also has a small pension from her first job, $500 a month from 65, with no cost-of-living increase. Their taxable account pays about $5,000 a year in dividends.
• Savings. $20,000 a year into their 401(k)s, employer match included, and $5,000 into the HSA, until they retire.
• Expenses. Living costs of $48,000 a year at today’s prices, about what they spend now. Once they’re on Medicare, medical costs of about $12,000 a year at today’s prices for premiums and out-of-pocket costs.

The home isn’t counted as retirement savings here. It still matters as a backstop for a large late-life cost, such as long-term care, and as part of what they leave behind.

Their Social Security claiming age is a choice. Claiming at 62 permanently cuts a benefit by up to 30%, and waiting past full retirement age adds 8% a year until 70 [2][3]. Because a surviving spouse gets the larger of the two benefits, not both [4], the higher earner’s choice also shapes the survivor’s income.

With everything in one place, Mark and Lisa can see what they have. The next question is what they want it to do.

Step 2: Establish a vision

Goals are the aim of a financial plan. Without them, there is no direction. At this point, Mark and Lisa know what they have but not yet what’s possible, so their goals are a first pass, and that’s enough to start.

A first pass still needs to be specific. “Retire comfortably” sounds like a goal but gives the numbers nothing to test. There is goal-setting research, spanning more than 40,000 participants, that finds specific, challenging goals lead to better outcomes than vague intentions to “do your best,” in part because a vague goal offers no clear standard [5].

Retirement studies point to a similar conclusion: workers with clearer retirement goals tend to plan more, and planning in turn is linked to how much they save [6][7]. Specific does not mean final, though. A date, a dollar amount, or an age can be written down now and changed later.

So Mark and Lisa start with a few basic questions and answer them as best they can for now:

• Why retire? People’s why may have several parts.
  • Time. Control of the calendar and fewer obligations. Mark wants a calendar he sets himself.
  • People. A spouse, children and grandchildren, aging parents, friends. Lisa wants more time with her sister, who retired last year.
  • Health. Energy for the active things while they’re still easy. Both put this near the top.
  • Purpose. Volunteering, mentoring, part-time work, learning something new. Mark wants to teach the grandkids to fish.
  • Place. Staying put, moving closer to family, downsizing, spending winters somewhere warmer. They’re staying put.
• When? Both wrote down 65, for now. A date is worth writing down even if it moves: in the latest edition of EBRI’s annual Retirement Confidence Survey, 46% of retirees said they left work earlier than planned [8].
• Will you keep working? Part-time work can be a goal in itself or a way to pay for other goals. Mark and Lisa won’t. A plan that counts on that income should also be tested without it: in the same survey, 74% of workers expect to work for pay in retirement, but 31% of retirees say they actually have [8].
• What will you do? Trips, hobbies, projects. Mark wants more time on the boat. Lisa wants one long trip a year.
• What will you give? Gifts to family, church, and charity. Lisa wants room to help with the grandkids’ college, and both want to keep up their yearly giving.
• How long should the money last? At 65, average life expectancy is roughly 18 more years for men and 21 for women [9], and many people outlive it, so planning beyond the average is common. Social Security’s Life Expectancy Calculator is a quick starting point. Mark and Lisa chose 95.

Put together, their goals come to about $24,000 a year at today’s prices: the boat, one long trip a year, help with college, and their yearly giving. Each one becomes a lever in the steps that follow: a date to move, a number to adjust, an age to plan for.

The list likely won’t stay this way. As the plan is built, the numbers evaluated, and the risks tested, possibilities may surface, and they can open the door to goals that weren’t on the first pass. For Mark and Lisa, that happens in Step 4.

Step 3: Map the cash flow

The map puts the facts and the goals together, one year at a time: every source of income before taxes (work, Social Security, pensions, and investment income), less every expense (living costs, medical costs, goals, and taxes). Whatever income doesn’t cover is the gap, and it comes from savings. Here is how they “plat” the map:

Set modest assumptions

Savings grow and prices rise, and a plan that ignores either can mislead. Mark and Lisa’s map uses modest assumptions:

• Returns: 5% a year on a balanced mix of stocks and bonds, with cash earning about the inflation rate. That’s below J.P. Morgan’s most recent long-term estimate for a portfolio of 60% stocks and 40% bonds [10].
• Inflation: 2.5% a year, a bit above the long-range assumption in the Social Security Trustees’ annual report [11]. Living costs, goals, and Social Security rise with it. Lisa’s pension doesn’t.
• Medical costs: 4% a year. Since the early 1980s, consumer prices overall have risen about 2.8% a year, while medical care prices have risen about 4.2% a year [12]. So their plan has medical costs rising 1.5 percentage points a year faster than other prices.

A note on dollars. The table and the yearly figures below are in future dollars, the amounts their statements would actually show. The two charts in Step 5 are different: they translate the results into today’s dollars, so the balances can be judged by what they would buy today. The difference matters, because a dollar at 90 buys about half what it does today.

Find the gap

For Mark and Lisa, the gap comes in two stages. At 65 and 66, before Social Security, it’s about $84,000 to $87,000 a year. That stretch is often called the bridge. From 67, the gap drops to about $31,000 a year, then grows, because Lisa’s pension is fixed and medical costs rise 4% a year.

Analyze the account mix

Each type of account is taxed differently, which gives a household a choice each year about which dollars to spend and how much taxable income to report. In general terms, under current federal law:

• Pre-tax 401(k)s and IRAs. Money went in before tax. Withdrawals are taxed as ordinary income, and required minimum distributions (RMDs) begin at 73 or 75, depending on birth year [13]. For Mark and Lisa, this is 75. Most heirs other than a spouse must empty an inherited IRA within 10 years [14].
• Roth IRAs. Money went in after tax. Qualified withdrawals are tax-free, with no RMDs for the original owner [13].
• Taxable account. Dividends and realized gains are taxed each year, often at lower long-term rates. Heirs generally receive the investments at their value on the date of death, so gains built up over a lifetime aren’t taxed as capital gains, a rule called step-up in basis [15].
• Cash reserve. Interest is taxable, and the value holds steady. It can cover spending after a market drop, so investments don’t have to be sold low.
• HSA. Withdrawals are tax-free for qualified medical costs at any age, including Medicare premiums other than Medigap. Contributions stop once Medicare begins, and after 65, other withdrawals are taxed like a pre-tax IRA. A spouse can inherit it as their own; for other heirs it becomes taxable income [16], one reason a household might plan to spend it on medical costs in retirement.

Rules like these depend on current law, which can change.

Decide where the gap comes from

The account mix turns the gap into a choice. A conventional rule of thumb spends taxable accounts first, then pre-tax, then Roth, letting tax-advantaged money grow longer. Another approach watches tax brackets: in low-income years (such as the bridge), pre-tax withdrawals fill low brackets that might otherwise go unused and can shrink later RMDs.

Mark and Lisa’s first pass leans on the second approach. During the bridge, the gap comes mostly from their pre-tax accounts, with the HSA paying Medicare premiums. The taxable account stays untouched, which keeps its growth eligible for a step-up for their heirs. The Roth waits for later years and large one-time costs, and the cash waits for bad markets.

Low-income years like these are also when a household might look at partial Roth conversions. They come with real trade-offs, and Mark and Lisa haven’t decided, so the table includes none.

Federal income tax stays modest, about $5,200 to $5,300 a year during the bridge and $1,600 to $2,000 once Social Security begins, because taxable income stays fairly low. All of this is an estimate; spending, prices, and the occasional surprise will move it.

Step 4: Check the key numbers

The cash flow map shows what the plan needs. Now, three measures show how sturdy the plan is: the withdrawal rate, the Monte Carlo simulation, and the set of guardrails. Together, they turn a budget into a spending plan.

The withdrawal rate

A withdrawal rate is the yearly draw from savings divided by the savings behind it. During the two bridge years before Social Security, Mark and Lisa’s rate runs a little over 5%, above the reference points below, because savings are standing in for the Social Security that starts at 67. From 67, counting dividends and the HSA, they draw about $37,400 from about $1.76 million, a rate of about 2.1%, and that ongoing rate is the one to compare with the usual reference points.

The best-known reference point is the 4% rule. Using U.S. market history back to the 1920s, financial planner William Bengen found that a 4% first-year withdrawal, raised each year for inflation, never exhausted the balanced portfolio he studied in less than 33 years; he suggested holding 50% to 75% in stocks [17]. Morningstar’s annual forward-looking research has put a comparable 30-year starting rate between 3.3% and 4.0% in recent editions, assuming fixed spending and a 90% probability of success [18]. Mark and Lisa’s rate sits well below both.

The Monte Carlo simulation

Mark and Lisa’s numbers above come from a projection that assumes steady returns, but markets do not act this way. Poor returns early in retirement are especially costly. In simulations, the plans that fail tend to be the ones with below-average returns in their first years [19]. A Monte Carlo simulation runs a plan through thousands of possible market paths, in good sequences and in bad, and reports a probability of success. It’s widely used but easily misread, so its analysis is typically work for a professional. A few notes on reading one:

• What it measures. The share of simulated market paths in which every planned goal is paid for, given the plan’s assumptions.
• A lower number isn’t a forecast of running out of money. It usually signals that in some paths the household would need to adjust, by spending a little less or working a little longer.
• A very high number can mean underspending. A plan that succeeds in nearly every path may be leaving goals, gifts, or time on the table.

Mark and Lisa’s simulation came back high, high enough to raise the underspending question. In plain terms, their savings may support more than their current map: bigger goals, an earlier date, or both.

The guardrails

Guardrails are a way to plan adjustments ahead of time, so a change is a rule rather than a reaction. Mark and Lisa use risk-based guardrails [20]. Each January, their plan is rerun through the Monte Carlo simulation above. If the odds of success fall below a floor they set in advance, they trim goal spending enough to bring the odds back up; if the odds rise above a ceiling, they raise it. Living costs, medical costs, and taxes stay put. The best-known version, from financial planners Jonathan Guyton and William Klinger, uses the withdrawal rate instead [21], but a fixed rate fits poorly when withdrawals change shape, as Mark and Lisa’s do before and after Social Security.

The spending plan

Together, the three measures become a spending plan backed by analysis: about $91,000 in their first year of retirement, $26,000 of it for goals, rising with prices each year, drawn from their accounts in a set order, with the plan rechecked once a year and goal spending adjusted when it crosses a guardrail.

That leaves two questions for Step 5: whether their plan can buy an earlier date, which is Mark’s question from the party, and how the plan holds up when things go wrong.

Step 5: Test what could change it

Testing shows what an earlier date costs, which risks matter most, and which levers answer them. Mark’s question comes first.

What if they retired at 63?

Retiring at 63 means one more year of contributions instead of three, four years before Social Security instead of two, and two years of buying their own health coverage before Medicare.

Marketplace premiums rise with age, up to three times what younger adults pay [22], and under current law, households with income above 400% of the federal poverty level generally get no premium tax credit [23]. Mark and Lisa budgeted $40,000 a year at today’s prices for coverage and out-of-pocket costs at full price, rising with medical costs, which brings their pre-tax withdrawals at 63 and 64 to about $113,000 and $117,000.

The space between the lines is what the earlier date costs: about $315,000 less at 67 and about $610,000 less at 95, in today’s dollars, because money spent early also misses the growth. Their withdrawal rate runs about 8% to 8.5% at 63 and 64, and at 67 it settles at about 2.7%.

What the earlier date buys is two more years of the goals from Step 2 (a calendar Mark sets himself, time with Lisa’s sister, fishing with the grandkids) while they have the energy for them.

Stress tests

So far, everything goes to plan. A stress test changes one assumption to see what happens if something doesn’t go to plan. We’ll look at three for Mark and Lisa: an early market drop, higher inflation, and long-term care (which more than half of people turning 65 are projected to need at some point [24]). For each, the chart shows what happens if they change nothing and if they pull one lever in response: smaller goals for the market drop, a later Social Security claim for higher inflation, and downsizing the home for long-term care.

A full plan may also test other risks, such as spending more than planned, a decade of low returns, a Social Security cut, the death of one spouse, and higher taxes; each one run through a Monte Carlo simulation.

• A market drop, met with smaller goals. In this test, their investments fall 25% in the first year of retirement and take three years to climb back to where they started; a slower recovery would hurt more. Even with the cash reserve spent first, as planned, and rebuilt once markets recover, about $500,000 less is left at 95 in today’s dollars, mostly because four years pass without growth. With the lever, they halve goal spending at 64 to 66, while their investments are below where they started. That gives up about $36,000 of goals in today’s dollars, cuts by nearly a quarter what they sell while prices are down, and leaves about $77,000 more at 95. If markets hold up, nothing is given up; if they don’t, the trim falls in the active years they retired early to enjoy. Holding more in cash and short-term bonds from the start is another approach, with its own costs.
• Higher inflation, met with a later Social Security claim. At 4% a year instead of 2.5% (with medical costs rising 5.5%, keeping their 1.5-point gap), about $530,000 in future dollars is still left at 95, but it buys only what about $140,000 buys today. Social Security keeps pace with prices; Lisa’s pension doesn’t. In this test, Mark waits until 70 to claim instead of 67, a choice he can make at 67 after five years of high inflation. The cost is about $100,000 more drawn from savings at 67 to 69, which keeps them more exposed to markets for those years. Waiting raises his benefit by 24% for life [3], so Social Security covers about 65% of their spending at 70 instead of 56%, and about $100,000 more is left at 95. The larger benefit also carries over to whichever of them lives longer [4], and waiting helps even if inflation stays at 2.5%, so it is worth weighing either way.
• Long-term care, met with the home. Medicare doesn’t pay for long-term custodial care [25]. The test adds two years of care from 85 at about $130,000 a year in today’s prices, near the national median for a private nursing home room [26]. In this test, they sell the home when care begins and move to one costing half as much, freeing about $176,000 in today’s prices after 6% selling costs. Gain on the sale of a main home is often partly or fully tax-free [27]; the chart assumes no tax.

Agree on the levers in advance

The point isn’t these exact levers. It’s the mindset of going into retirement expecting to adjust, with the levers chosen in advance, so a bad stretch calls for a plan rather than a scramble. This matters when a Monte Carlo result comes back lower than a household would like.

Research supports that flexibility, and the cuts can be smaller than people fear. In one analysis, risk-based guardrails called for much smaller cuts than the traditional rules [20].

On these numbers, 63 can work, with a condition: Mark and Lisa agree on their levers in advance, in the order they would pull them:

1. Spend from the cash reserve in a down year, so investments aren’t sold low.
2. Trim goal spending while markets recover, and adjust it as the numbers move.
3. Weigh a later Social Security claim for Mark, especially if inflation runs hot.
4. Keep the home in reserve for a large late-life cost.

Which levers are worth pulling is a judgment call, and course corrections can go both ways. Some households keep spending as if nothing changed after a bad stretch. Others spend less than they could: one study found 65-year-old couples are drawing only about 2% a year from savings, roughly half of what the authors estimate they could safely spend [28].

That is why establishing a vision early matters (Step 2). Without it, the primary measure is the balance at 95, and by that measure working longer and spending and giving less nearly always wins. Measured against what they want the money to do, 63 is a real option with a price they can see and a set of rules to keep it on track.

What a full plan adds

Everything so far answers one question: can Mark and Lisa retire sooner? A comprehensive plan goes further and looks for ways to win back part of what the earlier date costs. Here are a few examples. None are in the projections above, and each has trade-offs:

• Health coverage. Before Medicare, drawing from cash, the Roth, or the taxable account would lower their taxable income, and income under the 400% line could qualify them for a premium tax credit [23].
• Roth conversions. Converting some pre-tax savings this year, pausing at 63 and 64 to protect that credit, then resuming while watching the income levels that raise Medicare premiums [29]. Smaller required distributions later can mean lower taxes for whichever of them lives longer, and for their heirs.
• Giving. From 70½, they can give straight from an IRA, and those gifts count toward required withdrawals without being taxed [30]. Before then, grouping several years of gifts into one year can make itemizing worthwhile.

Hiring a financial planner is one more lever, with a cost to weigh against the help. If they hire one, the fee comes out of returns; the 5% used here is after all investment costs, including any advisory fee. Some households may do this well on their own.

What comes next

A plan is only as good as what gets done next, so Mark and Lisa’s list becomes actionable:

• Get real quotes for health coverage at 63 and 64. Lisa, by the end of the month.
• Confirm both Social Security estimates and check their earnings records. Mark, by the end of the month.
• Finish the one-page spending plan for each date: the first-year amount ($91,000 at 65), rising with prices, the withdrawal order, the guardrails, the levers in the order they’d pull them, and a date each January to check them. Both, before January.
• Decide whether to get help with the strategies above, from a planner or on their own. Both, before choosing a date.
• Choose between 63 and 65 once the quotes are in. Both, by the end of next month.

From here, the plan stays current as the numbers move, with their CPA and attorney in the loop. Our retirement page describes how Toft Wealth approaches this stage. Once there’s a working plan, the next question is how to invest the savings to support it, including a bucketing and asset location strategy. That’s where our next article picks up.

On a first pass, the question has changed. It is less whether they can retire and more which date they prefer, and what the difference actually means.