I Need $3500 Per Month to Cover My Expenses. Should I Take Social Security or Tap My 401(k)?
2 days ago
0 6 minutes read
Financial advisor and columnist Jeremy Suschak
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I’m retired and receive a pension but I still need to supplement my monthly income. My choices are to claim Social Security or start withdrawing money from my 401(k). I’m 64 and have $200,000 in a 401(k). My Social Security estimates are around $2,600 a month. I need $3,500 a month to pay bills. Your advice?
– Bob
The situation you face is common among current and soon-to-be retirees, but unfortunately, there is no one-size-fits-all approach. While I cannot cover all the factors you should ultimately consider, I’ll address a few that will hopefully help you make progress toward an eventual decision. I’ll also outline some of the tradeoffs between taking Social Security early and drawing from your 401(k).
The first and most obvious step you should take is to calculate your income gap. Presumably, you have already done this. But to facilitate some examples, let’s assume your pension provides $1,500 per month, leaving a $2,000 gap for either Social Security or your 401(k) to bridge.
Now, let’s look at the tradeoffs between the two options you raised, assuming a $2,000 per month income shortfall.
At your current age of 64, claiming the estimated $2,600 monthly benefit would fully cover your assumed income gap and even leave a surplus of about $600 per month. Again, this is a hypothetical based on the assumption that your pension pays $1,500 per month.
The immediate and obvious benefit of this option is that you do not have to withdraw from your 401(k), allowing that money to remain invested and potentially grow. However, taking Social Security at 64 locks in a permanently reduced monthly benefit.
If you wait until full retirement age (FRA) at 67, your benefit will increase by about 8% per year until you reach age 70. You should use the Social Security Administration’s benefit calculator to estimate what your benefit would be if you delay until your FRA or even age 70 since that could further inform your decision.
Any extra income generated by waiting to collect Social Security could make a meaningful difference later in retirement, particularly as costs increase due to inflation and potential healthcare expenses arise. This would also reduce the future burden on your 401(k) savings when the time comes to begin drawing on them.
(And if you need additional guidance as you plan for Social Security, consider speaking with a financial advisor.)
To continue the previous example, let’s assume you delay Social Security until you turn 67. This means you’ll need to draw from your 401(k) for three years to cover the $2,000 monthly shortfall. Over one year this is $24,000, and over three years this is $72,000 in expenses covered by your 401(k).
However, remember that traditional (i.e., non-Roth) 401(k) withdrawals are taxed as ordinary income, so you’ll need to withdraw more than you actually need in expenses to cover the tax consequences of those distributions.
If your income perfectly matches your $3,500 in monthly expenses, then this is $42,000 per year in income, placing you in the 12% federal tax bracket. If you live in a state with state income taxes, then you’ll also need to account for this. Let’s assume you do and, for simplicity, that the state income tax rate is 5%. Under these assumptions, you would need to draw approximately $29,000 per year to bridge the income gap while accounting for taxes on your 401(k) withdrawals. Over three years, this will leave you with approximately $113,000 assuming no investment gains or losses.
By taking this approach, you would delay Social Security and lock in the higher benefit at either your FRA or later, reducing the likelihood that you’ll need to rely heavily on your 401(k) later in retirement. However, this approach assumes your 401(k) investments remain relatively stable in the meantime and you can sustain the withdrawals without excessive market losses. This also reduces the future support your 401(k) can potentially provide.
(Remember, a financial advisor can walk you through the potential tradeoffs of different retirement income strategies. Speak with an advisor today.)
Of course, these are simplified examples based on the information provided and a number of assumptions that will require clarification before making a decision. Here are some additional considerations you may want to take into account to further refine your analysis and inform your decision.
(And if you’re concerned about any of these considerations, consider working with a financial advisor on a plan to deal with them.)
Family situation: Do you have a spouse and/or children to factor into the equation? If so, additional healthcare or other expenses should be evaluated. If you have children, do you have any legacy goals?
Expenses: If you do not have a spouse or children and you expect your expenses to remain stable, locking in Social Security early may be appealing. If you anticipate higher costs later on (healthcare, inflation, etc.), which is prudent to assume, then delaying Social Security for a larger guaranteed income might make more sense.
Health and longevity expectations: If you have a family history of longevity and good health, then delaying Social Security provides more financial security in your later years since it is impossible to predict what might happen in the markets and, by extension, what to expect from your 401(k) investments. However, if you have health concerns that may limit your lifespan, then taking Social Security early could allow you to maximize benefits while you can fully enjoy them.
Insurance coverage and healthcare costs: Do you have long-term care insurance? If not, then preserving your 401(k) could be valuable for potential long-term care expenses. Medicare eligibility starts at 65, but it doesn’t typically cover long-term care. Furthermore, out-of-pocket healthcare costs may continue to rise in the future.
Investment risk and market volatility: If your 401(k) is heavily invested in stocks, then a market downturn could significantly impact your withdrawals. A more conservative portfolio might mitigate risk but could also limit growth.
Required minimum distributions (RMDs): At 73, you must begin taking RMDs from your 401(k), which could impact your taxable income. If you withdraw early, then you may reduce future RMDs, which can help with tax planning.
Other sources of cash: Do you have other sources of savings and/or investments, such as a savings account or brokerage account? If so, then these could supplement your income and specifically reduce the burden on your 401(k). However, be mindful of maintaining a sufficient emergency fund should unanticipated expenses arise.
Unfortunately, there’s no black and white answer to your question in the absence of some critical pieces of information. However, some simplified conclusions could be drawn using the information provided. If you expect to remain in good health and if you want a stable income, then delaying Social Security until your FRA and using your 401(k) savings in the interim could make sense. This would presumably maximize guaranteed income for the remainder of your life while preserving some retirement savings.
Alternatively, if you prioritize immediate security, are facing health concerns or want to avoid withdrawing from your 401(k) to preserve growth, then claiming Social Security now might be a better option. Although this would lock in a lower Social Security benefit, it would more than cover your income gap without tapping your investments. Whatever choice you make, be sure it incorporates all the necessary pieces of information and aligns with your long-term goals, health outlook and overall retirement strategy.
Managing withdrawals efficiently helps extend the longevity of retirement savings. The 4% rule provides a general guideline, but market conditions, inflation, and personal spending habits should shape a more tailored approach. Dynamic withdrawal strategies, such as the guardrail method, adjust spending based on portfolio performance to help reduce the risk of depleting assets.
A financial advisor can help you build a financial plan for retirement that’s tailored to your specific goals and expectations. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with 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.
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Jeremy Suschak, CFP®, is a SmartAsset financial planning columnist who answers reader questions on personal finance topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Jeremy is a financial advisor and head of business development at DBR & Co. He has been compensated for this article. Additional resources from the author can be found at dbroot.com.
Please note that Jeremy is not a participant in SmartAdvisor AMP, is not an employee of SmartAsset and he has been compensated for this article.Â
