Oops, I may have broken my nest egg

Financial success can be due to making good decisions or avoiding big mistakes. In many cases, the biggest mistakes happen after good decisions, because the stakes have become higher.

As an example, let's consider the dilemma of Motley Fool reader Jim, who emailed us this question: “Did I make a substantial error when taking money out of my IRA?”

To help answer that question, Jim sent along some details:

  • He's retired.
  • His IRA was worth $325,000.
  • He couldn't get a mortgage.
  • He used $150,000 of his IRA to buy a house.
  • He receives $24,000 annually from Social Security.

Now, that's not all the information we'd need to determine whether he treated his IRA with TLC. But from what he told us, I'm going to make an initial diagnosis: He made a few mistakes.

As a cautionary tale for all us retiree wannabes, let's take a look at some important lessons from Jim.

Lesson #1: Crunch your numbers before you retire

The good thing that Jim did was save for retirement. In fact, he had a bigger nest egg than most retirees, according to the Employee Benefit Research Institute's 2012 Retirement Confidence Survey. Only 15 percent of the participating retirees reported having more than $250,000 saved up.

Unfortunately, being significantly above average still may not be good enough, especially since it's my opinion — based on studies and anecdotal evidence — that too many people retire too early. (NPR's series about Americans working longer mentioned a woman in her 90s who had to go back to work.) Having more than most retirees may be like being one of the best players on the practice squad.

Determining whether you have enough to retire can be a complicated analysis, perhaps best done by paying a fee-only financial planner who charges by the hour or by the project — such as many of the folks in the Garrett Planning Network — to help with the ‘rithmetic. However, for the purposes of this article, we'll use the 4 percent withdrawal rate rule: a rule of thumb that says retirees should withdraw no more than 4 percent of their portfolio in the first year of retirement, and then adjust that amount every subsequent year for inflation. (There's plenty of debate about whether 4 percent is actually best number, but it's good enough for this discussion.) So, 4 percent of Jim's $325,000 IRA is $13,000. Add it to Social Security, and he has income of $37,000.

But wait! He no longer has $325,000. That's because he didn't know about Lesson #2, which is…

Lesson #2: Get a mortgage before you retire

Ideally, you kill your mortgage (after all, “mort” is “death” in Latin, and the “gage” part means “pledge”) before you quit your job. However, if you're in the position of needing a mortgage in your 60s, you'll be more likely to get one while you're still working because you're still earning a paycheck and likely have a higher income. Also, it's against IRS rules to use an IRA as collateral for a loan.

Lesson #3: Avoid large traditional IRA distributions

Unfortunately for Jim, he didn't get a mortgage, so he made a $150,000 withdrawal from his IRA. Assuming this is a traditional tax-deferred IRA, that withdrawal was taxed as ordinary income — likely vaulting him from the 15 percent tax bracket to the 28 percent tax bracket. Thus, to have $150,000 to spend on a house, he likely would have withdrawn something closer to $180,000 to cover both the price tag and tax tag.

All still may not be lost

Assuming Jim has $145,000 left in his IRA (i.e., he withdrew $180,000 from the $325,000 he had), applying the 4 percent rule of thumb to that amount (resulting in $5,800), and adding that to his Social Security ($24,000) gives Jim an estimated annual income of approximately $29,800. According to the Department of Labor's 2010 Consumer Expenditure Survey, the average household led by someone age 65 or older has annual expenditures of $36,802. Jim might be OK if he keeps his retirement modest; he doesn't have a mortgage, so he just needs to worry about maintenance as well as food, utilities, transportation, taxes (which will be low for him going forward), and health care (not so low, and growing). Also, if he needs extra funds, he can get a reverse mortgage, which could add another few thousand dollars of annual income, depending on his age. However, this doesn't leave much room for unexpected big-ticket home repairs or health repairs.

Even though he's retired, it's not too late for Jim to crunch his numbers to determine whether he can be reasonably sure that his portfolio will last the rest of his life. If it looks like that isn't likely, then he has to change one of the key variables – income (i.e., go back to work), expenses (lower them further), or life (shorten it — the least-attractive option). Even working for a few more years, even part-time, can have a powerful impact on your retirement security. And it's better to do it now rather than wait until your 90s.

More about...Home & Garden, Planning, Retirement

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Sam
Sam
7 years ago

Often times I think we are saving too much because we compare ourselves to the average (here only 15% of retirees have $250,000 saved). But, then looking at the math I think we are not saving enough.

Plus relying on Social Security when these benefits are in play in the political arena seems foolish. We exclude SS payments from our calculations.

Mrs PoP @ Planting Our Pennies
Mrs PoP @ Planting Our Pennies
7 years ago
Reply to  Sam

We exclude SS to be on the safe side as well. There doesn’t seem to be a mention of how old Jim is here. Wouldn’t that play into how much he feels he can reasonably withdraw from his nest egg? Presumably if you’re in your 90’s you might have a different comfort level at withdrawing some of the principal for living expenses. Depending on where Jim lives and his comfort level, it might also make sense to rent out a bedroom in his new house to another retiree. It can be comforting to have another person around, to keep an… Read more »

Dee
Dee
7 years ago

Although renting our a room seems like a godsend both financialy and socially, I did and I would never do it again. I had to call the police to try and get the “roommate” out of my home. And, this is a person I knew before!

Juli
Juli
7 years ago
Reply to  Sam

Agreed. DH and I are both currently 35, with about $50k between my 401k and his Roth IRA. I struggle between how much to put into our emergency fund, and how much to put into retirement funds. By the time we reach retirement age, I expect we will get little to nothing out of SS, despite all the money we have contributed over all those years.

Lincoln
Lincoln
7 years ago
Reply to  Sam

I am in my early 30’s, and should have 200K in my 401(k) by the end of the fiscal year.

TB at BlueCollarWorkman
TB at BlueCollarWorkman
7 years ago

The ‘average’ American is overweight and in debt, too. So it’s definitely not a great idea to just compare yourself to the average!

Phoebe@allyouneedisenough
7 years ago

My husband and I are 29 and also don’t count SS in our future retirement calculations. I think it’s interesting that the writer says that people often retire too soon, and I wonder if this is a bandaid after someone has reached retirement age and doesn’t have the amount of assets expected, or if this is his general philosophy?

Peter
Peter
7 years ago

I believe he is making an observation. He is talking about people who retire, but do not have the money to actually retire. So they end up in further debt or need to return to work.

I’d assume if you have the funds to do so, he’d be supportive of retiring at any age.

Lance @ Money Life and More
Lance @ Money Life and More
7 years ago

I wasn’t aware how the word mortgage came around but that is definitely a neat tidbit. I never would have thought of Jim’s problem of getting a mortgage when retired so this seems like a great learning tool. I am hoping to have any mortgages paid off before I retire, but if I downsize and wanted to take advantage of low rates I am glad I now know that might not be possible le.

Laurel
Laurel
7 years ago

The meaning of “mortgage” was quite a neat tidbit. Also, I laughed when the author mentioned changing the 3rd variable, length of life, by shortening it. Funny stuff. At least he advised against it.

Adam - HireMeHigherEd
Adam - HireMeHigherEd
7 years ago

It’s easy to demonize someone for spending their retirement on a mortgage, but you are right, he may be bale to live very modestly, with his income from SSI, and the remainder of his IRA. I would probably advise reader Jim to work some form of a part-time job in retirement to make some extra cash.

Ramblin\' Ma\'am
Ramblin\' Ma\'am
7 years ago

I’m doing better than my age group too, but that’s not comforting. The average 30-year-old has something like $5K in retirement!

I also don’t figure SS income into retirement calculations. That way, anything I get will be a nice bonus.

Anne
Anne
7 years ago

While it seems (especially with current rates) it would have been best to get a mortgage before retiring, I think if he lives modestly Jim could probably get a part time job to delay further tapping the IRA. Working 20 hours a week or so at a minimum wage job would keep him under the threshold where it would affect his SS payments while replacing the 6k he may otherwise need from the remaining nest egg. Having worked in a movie theater in high school I would recommend looking into that- it’s air conditioned, high school workers can’t work during… Read more »

Adam Jaskiewicz
Adam Jaskiewicz
7 years ago

If Jim lives reasonably frugally, 30k per annum and a paid-off house isn’t too bad. If he can find a way make some money from a hobby, that would be a great way to supplement and occupy time with something enjoyable, too.

My Financial Independence Journey
My Financial Independence Journey
7 years ago

What wasn’t addressed is whether he would have been better off financially not buying the house and just renting instead. It’s entirely possible that a 4% withdrawal plus social security could have provided him with more spending money had he rented rather than raiding his IRA to buy a house.

The other point that’s not mentioned is that when (not if) he needs to make major repairs to his house, he’ll have to pay for them by further grinding down his nest egg. Again, another argument that maybe he should have stayed a renter.

Marsha
Marsha
7 years ago

My husband and I (both early 50’s) have diligently saved for retirement for nearly 30 years, and are on target to have a comfortable retirement, with or without Social Security. What concerns me is how few of our peers have saved anywhere near enough, and what effect that may have on our retirement. The elderly tend to vote more than the young, and a large group of elderly poor people could vote for increased taxes and means-testing for those of us who did save.

Sam
Sam
7 years ago
Reply to  Marsha

Yes that seems to come up time and time again, means testing for benefits like Medicare and Social Security which in my mind just punishes those of us who are scrimping and saving for retirement and provides further disincentive to save.

Kevin M
Kevin M
7 years ago
Reply to  Sam

I disagree. Would you really not save for retirement because you don’t want to lose out on the small amount of money you’d get from Social Security? That would be like not getting a job because you’d lose out on Unemployment Insurance. Yes, there are a few people who live like that, but thankfully not the majority. Second, I’d be happy to be subjected to means testing for Social Security if the government is actually reducing some spending. Entitlement spending is a large part of the budget, and would provide a significant start to reducing the deficit. Now, if they… Read more »

Peach
Peach
7 years ago
Reply to  Marsha

If there are a lot of elderly poor people who are unable to support themselves when I retire, I think I would be more concerned about helping them avoid homelessness and hunger, than worried about how their plight would affect the comfort of my retirement. With millions out of work for years, having no health insurance and having to use their retirement funds just to survive, they will need help getting back on their feet, even after the economy stabilizes. I’m grateful for my IRA funds, but I know not everyone has the means to save for their own retirement.

Jacob @ iHeartBudgets
Jacob @ iHeartBudgets
7 years ago

Should have called his accountant! Oh well, I saw this with one of my clients this year as well, almost the same amount.

I really hope he has long term care insurance, because at $30k a year to play with, that will disappear VERY quickly if his long-term care is not covered.

Diane
Diane
7 years ago

Hubs & I are 30 & 32, with about $57k in Roth IRA, Traditional IRA & 401k. I feel like complete crap about that number and feel we should be more towards the $70k – 75k than where we are. I am counting on $0 from SS. Maybe some inheritance money from my parents (my Dad is a big saver, but I think he might blow a chunk of his money on traveling with my mom when he retires – as he should!!!) – but not counting on that at all! However, looking at having $325,000k and SS and retiring,… Read more »

Noxius
Noxius
7 years ago
Reply to  Diane

Diane,

You are doing fine. Just add 3% a year to what you are saving and you can retire at 55.

I did it and I am 77 and spending my children’s inheritence traveling. Don’t rely on inheritance.

Read the book, “Die Broke,” for good humor and advice.

Brianne
Brianne
7 years ago
Reply to  Diane

Diane,

I feel like crap about how much we have saved too. We’re 33 and 34 and we have about $150K between our 401Ks and my Roth. It doesn’t seem like enough. I only saved 10% in my 20s and now I regret it. Plus, we still have student loans because we both went to grad school and didn’t keep paying while they were deferred.

Panda
Panda
7 years ago
Reply to  Brianne

This is an area where I feel really really fortunate for the guidance I had from my father when I was starting to work. I’ve completely front-loaded my retirement savings. During my 20s I was maxing out my 401k and IRA. And while that meant I had a lot less to live on, it was certainly easier to put the money aside then than it is now with a house and a baby. So now I’m temporarily putting aside less (enough to get compnay match) but the balance in my accts still has me far ahead of the average 33yo.… Read more »

Kingston
Kingston
7 years ago

It concerns me greatly to hear practically everyone here state that they expect never to receive Social Security benefits, and to state this with no sense of outrage. The folks out there who would like to see Social Security privatized or dismantled must be very glad that so many younger people a) seem convinced that maintaining the program is a lost cause, even though reputable economists state otherwise and b) seem to have no stake in its existence and good health. We don’t have to let them just take it away. We could, for example, raise or eliminate the payroll… Read more »

Marsha
Marsha
7 years ago
Reply to  Kingston

Do you also advocate raising the benefits received by those who pay in more than what the current cap is? The benefits you receive in retirement are directly tied to the amount of income you made in your work life. If those who paid in more do not receive more SS income, then this is simply an additional tax on higher income workers, and more money for the government to waste.

Mom of five
Mom of five
7 years ago
Reply to  Kingston

I can’t speak for the others, but as a not so young person – I’m 46- I’ve got plenty of outrage as we’re also not figuring on getting back any of the hundreds of thousands we’ve paid into SS. But what’s the point of expressing outrage here? This is a personal finance blog, not a political forum.

Deb
Deb
7 years ago

One of the co-workers that retired the same time as my husband took money out of his 401k to “pay off bills” so he could afford retirement. Then he used some of the funds to buy a truck. Then he withdrew the rest to put into an IRA. Notice I didn’t write “transfer or rollover.” He talked with disdain about the stupid people at his 401k custodian’s office, trying to talk him out of it because they didn’t know any better and wanted to keep his money. They made all kinds of dire IRS predictions. Then he took half of… Read more »

Barbara
Barbara
7 years ago

Deb, I have a co-worker who did something similar except that he also took a lump sum payout from his state pension. He was shocked to find he owed taxes on the money and was back to work within a year after blowing through the money on expensive cars and a European vacation that he paid for friends to accompany him and his wife on! Now he is 72, in poor health and tells me he hopes he will be able to retire in “3 or 4” more years. I predict he will die on the job. How sad but… Read more »

jim
jim
7 years ago

To all you 20/30/40 somethings out there – PLEASE SAVE HUGELY for your retirement – NOW. After getting our youngest thru college debt-free we were on a pretty good track for retirement – until our parents got very ill and our youngest decided to go on to grad school. Bye-bye retirement. Life throws you all kinds of curves. Save for the unexpected ’cause it will surely come knocking at your door. Best of luck to all of youl.

Jesse
Jesse
7 years ago
Reply to  jim

“our youngest decided to go on to grad school”

This kind of comment confuses me. Why do parents feel the need to own their children’s financial decisions? Cut the cord, let her learn the lesson.

Not saying grad school is a bad thing at all, just saying that she’ll learn more by paying it herself.

Unsure
Unsure
7 years ago

Okay, am thinking of tapping our 401ks for a down payment on a home. DH and I would take out $5,000 each towards a down payment on our first home. We are in our 30s and each account has $40k in it. We weren’t planning to buy for another 4-5 months, to continue saving and then we saw our dream house. The kicker on the house is the lot. In our area very few properties have mature trees as the land is mostly converted farmland and all the new developers have knocked down the few trees that were there. Trees… Read more »

EMH
EMH
7 years ago
Reply to  Unsure

I took out $10k from a 401k to help with the downpayment for our home. I’m sure that $10k would have grown to much more in my 401k but I absolutely love our condo and I don’t regret it at all. I still put the max into my 401k and our condo will be paid off in a few years so I can then use what would have been the mortgage payment into an IRA. This doesn’t answer your question but you have time on your side and you don’t need to live off the 401k right now. If you… Read more »

Unsure
Unsure
7 years ago
Reply to  EMH

Thank you for sharing your experience!

@pfinMario
@pfinMario
7 years ago

That’s interesting that a lender would give significantly better rates to someone about to retire compared to someone already retired. Can’t a lender know they’re about to quit?

Mr.Bonner@bonnersbillions
7 years ago

We’re in our early 30’s and just crossed $200K in our retirement accounts. A few months ago I just cut back my 401k contributions to the minimum required to take full advantage of my company match (they put in 2% automatically then match 4% dollar for dollar, so I only contribute 4% now). I have always contributed way more, but now we want to save to buy a house, so rather than investing heavily in a high market I’ll stash the cash it in the new house fund for the next few years.

Unsure
Unsure
7 years ago

Okay, we are thinking of cracking our 401ks for a downpayment on our first home. We’re $10k short and so DH and I would borrow $5k each. We are in our 30s and each account has $40k in it. Our preference would be to wait another 3-6 months before buying but we’ve fallen in love with a home that we’re afraid of losing. There is plenty of affordable housing in our area, but actually not much with mature trees as the land is mostly converted farmland and new developers have cut down the few trees that were around. Trees are… Read more »

Unsure
Unsure
7 years ago
Reply to  Unsure

sorry for double posting, didn’t think it went through the first time!

Mom of five
Mom of five
7 years ago
Reply to  Unsure

I’d first try to get a mortgage with the downpayment, but personally I wouldn’t rule it out. I think having a paid off home is key to retirement planning for most of us – it certainly is for my husband and me. So I wouldn’t so much look at taking money for a downpayment as raiding a retirment account as much as moving retirement funds around.

Tony@WeOnlyDoThisOnce
7 years ago

Incredible numbers and very clear insight, Robert. Definitely food for thought, and action. Great post.

Retirmentbuff
Retirmentbuff
7 years ago

We are 30 with 120K together in Roth IRA & 401k. We have some rental properties in addition to our primary jobs that are paying themselves off. At this point not sure what to do investment wise beyond maxing out the 401Ks and the Roth. Worried about the future cost of caring for ageing parents at about the same time we would start a family give or take five years. I would like to invest in instruments now that can hold through potentially rocky years. If the older generation has little to no savings and you want to be proactive… Read more »

Dee
Dee
7 years ago

Thank you for posting a topic for the older set. Although time is not as long for me to get rich slowly (I lie about my age so I am no longer sure how old I am.), I like to see age appropriate posts like this, and it does give a long term perspective for younger readers.

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