Retiring soon? Plot a detailed budget first before tapping your 401(k)

You might know how to save for retirement. But do you know how to spend your savings after you retire?

For decades, the “4% rule,” laid out by renowned financial adviser William Bengen, served as the north star for financial planners. He estimated that a withdrawal rate of 4% a year would allow a retiree to safely spend down their investment account without depleting it.

To get his estimate, Bengen used historical data across three decades, which included boom markets, downturns and swings in inflation, as well as various types of portfolios. However, the model didn’t consider how much retirees actually have saved, which is often far less than they expect to stash away during their working years. In fact, just 29% of retirees say their 401(k) or IRA is a major source of their income, according to Gallup.

Americans between 60 to 64 have a median balance of only $66,900 saved in their employer-sponsored 401(k), while those 65 to 69 have $63,100, according to Fidelity, the largest administrator of workplace retirement plans. Meanwhile, the average balance — which is skewed upward due to the retirement wealth concentrated among the richest Americans — is $239,500 and $244,000, respectively, for those cohorts. And the share of 401(k) millionaires is relatively small, at 2%, according to Fidelity. (Those numbers don’t account for an individual holding multiple retirement accounts.)

However, all retirees — no matter their portfolio balance — need a flexible withdrawal rate, experts say.

“We don’t actually see spending moving in a straight line, which is what the guideline assumes,” says Christine Benz, director of personal finance and retirement planning for Morningstar. That means finding a rate that matches your true retirement income needs from one year to the next, factoring in other sources of income — such as Social Security benefits, a pension or other savings — as well spending in the later years on health-care costs.

And among those who do have more than enough, they might be too constrained by what John Boyd, a certified financial planner in Scottsdale, Arizona, calls “saver’s mentality”: When they retire, they know about the 4% rule, but err on the side of underspending.

“I don’t think they give themselves enough credit on how much they can spend,” Boyd said.

Inflation’s bite

Pre-retirees often wrongly assume they should withdraw a flat 4% every year. In fact, this is just a starting point, with the dollar amount adjusting for inflation year over year.

For example, let’s say a retiree had $1 million in their 401(k). Under the 4% rule, they would withdraw $40,000 for the first year of their retirement. They would then have to adjust the next year’s $40,000 withdrawal by the inflation rate. If inflation comes in around the Federal Reserve’s traditional target of 2%, that would mean an extra $800 withdrawn in the second year of retirement — that is, 2% of that original $40,000. But if that retiree had to withdraw in June 2022, when inflation hit 9.1%, they would pull out $3,640, for a total of $43,640.

Another source of pressure in 2022 was the severe market turmoil — depressing returns on stocks as well as on bonds across many investment vehicles, including target-date funds. So many savers saw their accounts take a hit, even those with a conservative mix of investments.

In cases of such down markets, a retiree should take out less — a tough pill to swallow — to avoid depleting their account too quickly, Benz advises.

Your budget vs. Social Security

For all those reasons, you should map out the first 10 years of retirement with a granular budget before thinking about the 4% rule or any other withdrawal rate, Benz says.

Those needs include more than just lavish vacations. Pre-retirees should specifically think about what kind of big-ticket costs to cover, such as a roof repair, new appliances, home renovations or replacing a car. Other items that pre-retirees often forget to budget for are their children’s or grandchildren’s weddings and graduations, she notes.

Once you make this granular budget, it’s time to crunch the numbers on how much your savings and investments, along with Social Security and a pension (if you have one), would cover. Replacing a car or your roof could mean taking more out of your 401(k) or IRA than what you originally expected.

Understanding how much support you’ll get from Social Security is especially crucial given the funding crisis facing the program’s trust fund — a long-term challenge caused by a declining worker-to-retiree ratio. At present, the trust fund is dwindling but is enough to cover 100% of scheduled benefits until 2035. After that, if Congress doesn’t act, benefits will fall by 21%.

For 2025, the average Social Security payment for retired workers is $1,976, reflecting the most recent cost-of-living adjustment. But you can see an estimate of your personal benefit by checking your Social Security statement at ssa.gov. The statement shows you three expected estimates: One if you claim benefits at 62, another at full retirement age (between 66 and 67, depending on your birth year), and the last if you delay benefits until 70. The later you take the benefit, the bigger it will be.

If the kind of long-term budget that Benz describes exceeds your savings, you may need to consider working longer. But working into your 60s is no guarantee, especially if health problems, family commitments or other reasons interfere. A 2022 Gallup survey discovered that non-retirees assume they will work until age 66. However, only 55% of Americans in their early 60s are still working, according to the Census Bureau. After age 65, that share drops to roughly a fifth.

If you can’t work longer to help steady your income and Social Security doesn’t suffice, you may have to consider more sweeping options, like tapping your home equity or downsizing to a less expensive area, Benz says.

The challenge of long-term care

Your personal withdrawal rate is expected to rise in your later years as health-care costs rise.

Starting at age 65, seniors get support through Medicare, the government-funded insurance program that covers things like doctor’s visits and hospitalizations, as well as certain drug costs. Some may also be eligible for Medicaid, the state-federal health system that covers low-income Americans of all ages. But there’s a growing crisis in long-term care, including memory care, which Medicare doesn’t cover beyond short stays. Seniors can turn to Medicaid in that case, but only if they have little to no income and limited assets. And it’s only for care deemed necessary, which the program will determine after giving you a full financial audit.

At present, more than 4 million Americans have some form of long-term care paid for by Medicaid, but aging baby boomers are by and large underprepared for the extraordinary costs of specialized care. In 2023, Genworth estimated that a semiprivate room in a nursing home cost $104,025 a year. For those looking to age in place, a home-health aide is almost as pricey, with an estimated cost of $75,504 a year in 2023 — and these estimates are going up. In 2033, Genworth projects these costs to be $139,801 and $101,471, respectively.

The best way to factor in such long-term health-care costs, therefore, is to set aside the money, experts say. For Melinda Satterlee, a CFP in Medina, Washington, that means subtracting say $200,000 out of a client’s investment portfolio to cover potential costs. From there, other necessities such as food, transportation, and housing are factored into a potential budget before determining their exact withdrawal rate.

The math may mean sharply reducing other spending, depending on how much a client has saved, Satterlee says.