The New York Times recently published an article headlined “For Retirees, a Million-Dollar Illusion,” which questioned whether $1 million in savings is enough to retire on, given today’s low interest rates and stock market volatility, the potential for inflation and increased life spans.
The article sparked a media frenzy – how could $1 million not be adequate, many people responded – and only served to further depress the majority of Americans with retirement savings of far less than $1 million.
So is $1 million enough money to retire on?
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Where $1 Million Might Not Be Enough
I’d say the answer is yes, unless perhaps you live in a high-cost area, like New York City or an affluent section of Los Angeles, San Francisco or Washington, D.C.
Even with $1 million, however, you’ll still need to make smart decisions about generating retirement income from your savings and when to claim Social Security benefits.
Let me show you how your retirement could work out if you’re part of a married couple who are both 65 and have $1 million in total retirement savings. I’ll also explain how you can retire with less than $1 million and reduce your anxiety about outliving your money.
The first step is to establish how much annual income you really need in retirement.
The 80 Percent Rule May Not Hold for You
The Times article cited the often-repeated goal of aiming for a retirement income equal to 80 percent of your pre-retirement income. As this theory goes, you’ll need less than 100 percent of your pre-retirement income because your income taxes will be lower in retirement, you won’t be paying FICA taxes or incurring work-related expenses and you won’t be saving any more for retirement.
The story estimated that a couple could piece together an annual retirement income of $61,000 to $71,000 with a $1 million portfolio and Social Security, but said that probably wouldn’t be enough for people accustomed to living on at least $150,000 per year. (That's the median income for the top 10 percent of households, roughly the ranking of a family with $1 million in assets.)
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Maybe living on $71,000 or so would be a challenge for readers of The New York Times, but I’m sure many Americans could do just fine on it. The U.S. Department of Labor’s Consumer Expenditure Survey shows that households headed by people age 65 to 74 had an average annual pretax income of $52,521 in 2011.
For many people, however, even the 80 percent rule of thumb overestimates how much retirement income you’ll need.
That's because you’ll need significantly less income compared to your career years if you’ve paid off your mortgage by the time you retire or shortly thereafter; you’re no longer supporting your kids financially; you won’t be taking expensive vacations each year and you don’t need to buy the latest car or electronic gadget.
You might well find that you can get by with a retirement income of 50 to 75 percent of your pre-retirement income.
The bottom line: Don’t use general rules of thumb. Estimate your budget for retirement living expenses, based on your circumstances. You might want to use a free online retirement planning calculator, like Fidelity’s Retirement Income Planner or the Employee Benefit Research Institute’s Ballpark E$timate calculator.
Indexing Retirement Income for Inflation
The Times article also repeated another oft-cited rule of thumb – that your retirement income must be fully indexed for inflation.
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While inflation should be a concern when planning your retirement, people actually spend less money as they age. For example, according to that Consumer Expenditures Study, households headed by people age 75 and older had an average annual pre-tax income of $32,144 in 2011, significantly below the average for people between 65 and 74.
This phenomenon could rationalize arranging for some retirement income that doesn’t increase fully for inflation.
How Much $1 Million Could Provide
By my calculations, our hypothetical couple with $1 million and Social Security could generate a total annual retirement income of about $75,000 starting at age 65. That’s well above the current average income for Americans 65 to 74.
More than half of that income – 60 percent – could be guaranteed for life, indexed for inflation and not impacted by stock market declines or interest rate volatility.
Here’s how the couple could assemble this retirement income:
The primary breadwinner would delay claiming Social Security benefits until age 70 using strategies advocated by Dr. John Shoven, director of the Stanford Institute for Economics Policy Research.
The breadwinner would “file and suspend” Social Security benefits at age 66, enabling his or her spouse to start receiving Social Security spousal benefits at 66. If you’re unfamiliar with this strategy, read an article I wrote about the file and suspend strategy.
The couple would set aside a portion of their retirement savings to withdraw between age 65 and 70. The annual amount withdrawn would cover the Social Security income they would have received beginning at 66 had they chosen to start taking the breadwinner’s Social Security benefits then.
The remaining assets from their portfolio would be split in half, with both halves devoted to generating retirement lifetime income starting at 65.
Half of this savings would be used to buy low-cost sources of lifetime monthly retirement income guaranteed by well-rated insurers. This pot would be split in half again, divided between an annuity with fixed monthly payments and an inflation-adjusted annuity.
If the couple was worried about the possibility that the insurer might go bankrupt, they could limit the purchase amount of each annuity to the amount guaranteed by their state’s guaranty association.
They’d invest the other half of their savings in low-cost mutual funds; 60 percent in stocks and 40 percent in bonds. The couple would withdraw roughly 4 percent of the remaining value of assets each year. The resulting retirement income would fluctuate, depending on the performance of the stock and bond markets.
Now what if you don’t have $1 million in savings?
Income From a $500,000 Portfolio
Well, let’s use the same strategies, but assume the couple has a $500,000 retirement portfolio.
By my calculations, they could generate a total retirement income of about $52,500 a year at 65, which is roughly equal to the average income for Americans in this age group. More than three-fourths of this income would be guaranteed and indexed for inflation.
And here’s another possible scenario: Let’s assume the couple will work part-time until age 70; have $500,000 in retirement savings that they won’t touch until they’re 70 and will still use the file and suspend strategy to start the spouse’s Social Security benefits at 66. (This example presumes they’ll be healthy enough to keep working and that they’ll be able to find part-time jobs.)
By my calculations, this couple would have a total retirement income of about $60,000 a year starting at age 70, with more than two-thirds of the money guaranteed and indexed for inflation.
So it is possible to retire with $1 million in savings – or even with half that amount.
By the way, the same strategies I’ve mentioned could be used for singles to achieve similar results.
P.S. Want to check my numbers? Here are my assumptions:
- Social Security income for the primary breadwinner would be $2,000 per month starting at age 66, the program’s “Full Retirement Age.” This amount is representative for benefits received by today’s 65-year-olds who’ve long earned around $75,000 per year, adjusted for wage inflation.
- The non-primary breadwinning spouse wouldn't be entitled to his or her own Social Security benefits due to the small number of years working. (A spouse who had earned Social Security benefits would only improve the results).
- Annuities would be purchased using a competitive bidding service. Their rates appear in a retirement income scorecard article I recently wrote.
- The retirement savings used to replace Social Security benefits from age 65 to 70 would earn an amount of interest equal to the inflation rate.