Forget Your 401(k) Balance. Here’s the Number That Really Matters.

When you’re in the process of saving for retirement, it’s natural to keep tabs on your 401(k) balance. Once retirement gets closer, you may start to fixate on the number you see on the screen, whether it’s $500,000, $1 million, or more.

When you look at that number, you might take comfort in the fact that it’s pretty large. But your 401(k) balance doesn’t tell the whole story.

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What actually matters more than your balance is the amount of income your retirement savings can provide each year. It’s crucial that you figure out what that number is before you stop working.

Your balance doesn’t tell you how much you can spend

Once you retire, you’re not going to empty your 401(k) in a single year (or, at least, you really shouldn’t). Rather, you might need that money to last 15 years, 20 years, or longer. That’s why translating your 401(k) balance into annual retirement income can be one of the most valuable exercises you do before leaving the workforce.

Let’s say you have $1 million socked away in your 401(k). You might assume you’ll be able to cover all of your spending needs. However, if you use the popular 4% rule, a $1 million balance in a 401(k) only translates into $40,000 of annual income plus inflation adjustments.

That may be enough to cover all of your anticipated expenses, especially if you have a generous monthly Social Security check coming your way to supplement your retirement plan withdrawals.

But let’s say you’re looking at $30,000 a year in Social Security and estimate your annual spending needs at $90,000. With just $40,000 a year in 401(k) withdrawals, you’re going to have to make some adjustments.

That could mean spending less in retirement or delaying retirement. Or it could mean compromising by retiring on time but working part-time for supplemental income. Either way, once you know how much annual income your 401(k) is likely to provide for you, you can see if your retirement plans hold up or if you need to make changes.

An important exercise to run through ahead of retirement

One thing you don’t want to do is retire and then figure out how much annual income your 401(k) will give you. In fact, it’s a good idea to run that calculation a few years ahead of retirement, so you have time to pivot if that becomes necessary.

A large 401(k) balance may look impressive when you pull up your account on your laptop, but it’s important to dig much deeper. By estimating your annual income, you can gain a much clearer understanding of the retirement lifestyle your savings can support. The sooner you crunch those numbers, the more time you’ll have to strengthen your financial plan before retirement arrives.

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Forget Your 401(k) Balance. Here’s the Number That Really Matters. was originally published by The Motley Fool