How to Stress-Test Your Retirement Income Before You Stop Working

If you're getting close to retirement, it's important to make sure you have enough money to bring your career to a close. And looking at your IRA or 401(k) balance isn't enough to make that determination.

You might be sitting on $2 million in your 401(k) plan, which sounds like a lot of money. But over the course of what could be a 25- or 30-year retirement, that balance could easily get whittled down.

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Now as a general rule of thumb, a good way to see if you have enough retirement savings is to estimate your annual income needs, subtract guaranteed income like Social Security, and see where that leaves you. From there, if you multiply that number by 25 and it matches what you have in savings, you should be in pretty good shape.

For example, say you estimate your annual income needs at $100,000. If you're expecting $36,000 a year in Social Security, you'll be looking to your nest egg for $64,000 on an annual basis. (This is a basic calculation and doesn't account for inflation adjustments to spending.)

If you multiply $64,000 by 25, the total is $1.6 million. So if you have $2 million saved, in theory, you're good to go.

However, it's still important to stress-test your retirement income in case things don't go as planned. Here are some key scenarios to plan for.

An early market downturn

One of the biggest risks retirees face is sequence-of-returns risk. If the stock market crashes early in retirement and you're forced to lock in losses from the start, your portfolio might never fully recover. That puts you at risk of potentially running out of money over time.

To test against this, model what might happen to your portfolio if the stock market were to drop significantly early on in retirement -- say, 25% to 30%. Then, see how you'd compensate.

If your plan is to maintain a cash cushion with a few years' worth of living expenses in a high-yield savings account, that, coupled with reduced spending, could potentially spare you from big losses during an early market crash. But it's important to have a plan for this scenario, since the market could tank at any time.

Stubborn inflation

Inflation doesn't need to soar to erode your retirement savings. Even if it's moderately elevated, a prolonged period of higher-than-average inflation could sting.

Run some projections that assume higher inflation and see how your savings hold up. Based on that, you may decide that it makes sense to delay your Social Security benefits and boost them in the process.

The reason? Social Security benefits are eligible for an annual cost-of-living adjustment. But your savings aren't guaranteed inflation protection. So having that built-in cushion could help.

Longevity and healthcare costs

In the course of your retirement planning, you may be operating under the assumption that you'll live until your late 80s or early 90s. But you may end up living longer than planned.

Similarly, you may be factoring in Medicare and healthcare costs. But what if you end up needing a few years of long-term care, which Medicare typically won't cover?

When testing your savings and income, run the numbers based on living until age 95 or even 100 to see if your plan works. And also, assume a couple of years of very expensive long-term care expenses to make sure your savings can absorb that outlay.

Stress-testing your retirement income plan isn't about eliminating risk. Rather, it's about having a backup plan when things go awry. By stress-testing against these scenarios, you can put yourself in a stronger position to manage them if they end up putting pressure on the nest egg you've worked hard to build.

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