The average American expects to need $1 million in retirement savings to feel financially secure, according to a 2015 survey by the Transamerica Center for Retirement Studies. But while $1 million can certainly go a long way in retirement, it's not necessarily enough for everyone.
What will your retirement costs look like?
Because everybody's retirement needs and goals are different, there is no one-size-fits-all retirement savings formula. It's easy to point to $1 million as a figure that should be enough to sustain most Americans in theory, but in practice, that just doesn't work. There are numerous factors, from housing to healthcare to transportation, that dictate how much money an individual needs to spend right off the bat. There's also the concept of leisure in retirement -- an expense that needs to be factored in. While one person might be content taking long walks in the park and enjoying afternoons with the grandkids, another might be aiming to travel and pursue other expensive hobbies.
The 4% rule
Some of your living costs in retirement may be harder to predict than others. Housing is one of those: even if you've paid off your home and expect to stay put during retirement, you still have property taxes, homeowners insurance, and maintenance costs that could go up. Healthcare can be a similar gamble, as you really have little way of knowing what medical issues you'll encounter 10 or 20 years down the road.
Without a crystal ball, estimating your retirement expenses boils down to guesswork, especially if you're decades away. But if you really want to know how well $1 million will serve you, you can start by weighing your current earnings against the 4% rule. The rule basically states that if you withdraw 4% of your retirement savings the first year and then adjust future withdrawals for inflation, you can expect your savings to last 30 years.
You can use the 4% rule to estimate your retirement savings target by taking the amount of income you expect to need each year and multiplying that figure by 25. So let's say your current income is $50,000. Most people require 70% to 80% of their pre-retirement income once they're no longer working, and if we stick to the high end, that gives us a $40,000-a-year income need. If you multiply $40,000 by 25, you'll arrive at $1 million.
Now there are additional factors to consider when estimating your retirement savings needs -- such as Social Security. But like your anticipated retirement expenses, Social Security can be hard to predict, especially if you're younger. While you can visit the Social Security Administration's website to get a rough idea of what your retirement benefits will be, your ultimate lifetime earnings average and the status of the Social Security trust fund could change those figures significantly. Though it's fair to assume that you'll see some money from Social Security, you're better off assuming that the majority of your retirement income will need to come from savings.
What will $1 million buy you in retirement?
Another factor to consider when you calculate your income needs in retirement is inflation. If you're several decades away from retirement and are trying to estimate how much money you'll need to pay your living expenses down the line, you're probably calculating those figures in today's dollars. But over time, inflation can seriously erode your purchasing power.
Let's say inflation rises 2% a year. In that case, a $100 purchase this year might cost you $102 next year. Over time, those differences can really add up. According to a study by the Senior Citizens League, seniors have lost roughly 31% of their buying power since 2000, largely due to inflation and Social Security's inability to keep up. So while $1 million might seem like a lot of money now, it may not buy you nearly as much 20 or 30 years in the future.
Though aiming to save $1 million for retirement is a respectable goal, the harsh reality is that depending on your circumstances and needs, it may not be enough to sustain your lifestyle once you're no longer working. So rather than fixate on that $1 million figure, aim to save as much as you can as early as you can, and invest that money wisely. With any luck, you'll amass enough to fund the retirement you've always imagined.
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