A million dollars is a lot of money, isn't it? Not when you're looking to finance your entire retirement. If you've got $1 million tucked away in your retirement savings by the time you're ready to retire, you won't starve, but you may not be able to live out your dreams, either.
"Millionaire" has been shorthand for "really, really rich" for a long time. Unfortunately, $1 million doesn't buy as much as it did when the term millionaire was first coined. You can blame it on inflation, which is the force that causes the dollar to be worth a little less each year.
Inflation varies from year to year, sometimes radically, but over the long haul, it's averaged about 3% in the U.S. That means that $1 million will buy 3% less stuff, on average, for each year that passes.
The 4% rule
Depending on when you retire, you may be living on your retirement savings for 20 years, 30 years, or even more. If you want your savings to last for the rest of your life, you have to be careful not to take too much out of those accounts each year.
Before the Great Recession, many experts advised withdrawing no more than 4% of your total retirement savings in any given year, but with the lackluster average performance of the market in this post-Great Recession economy, the recommendation has changed to no more than 3% to 3 1/2% withdrawn each year, particularly during the first few years of retirement.
Doing the math
If you're taking no more than 3 1/2% from your retirement savings each year, and you have $1 million saved, you're getting an income of $35,000 per year from your retirement savings. Let's say for the sake of argument that you also have a monthly Social Security benefit of $2,000, which is well above average. That adds up to a total annual income of $59,000.
While that amount is enough to live comfortably in most parts of the U.S., it won't fund an extravagant lifestyle. And remember that, thanks to inflation, by the time you're ready to retire, even $59,000 a year won't be worth as much as it is today.
Setting your expectations
That's why it's important to know what you want to do during your retirement and save accordingly. If you plan to lead a simple life in retirement, focusing on family events and low-cost activities, then $59,000 a year is probably plenty. On the other hand, if you dream of living on a cruise ship, or touring the capitals of the world, $59,000 a year won't be anywhere near enough. If that's the kind of retirement you want, you need to save more.
Figure out how much annual income you'll need to cover your expenses during retirement. Multiply that number by the number of years you expect to be retired. Then grab a savings calculator and find out how much you need to be saving each month to hit your goal in time for retirement.
But I can't save that much!
If you went through the above exercise and the number that popped out was high enough to turn your hair white, you may need to adjust your retirement plans. There are two basic options: increase your income, or reduce your expenses.
You can increase your retirement income by identifying other sources of income, such as a part-time job or delaying your retirement by a few years in order to shorten the amount of time you'll need to finance your golden years. This will allow you to withdraw a slightly higher percentage from your retirement savings since you won't need the money to last as long. You could also find ways to increase the return you'll make on your retirement savings -- unlikely, but possible.
You can reduce your retirement expenses by scaling back your plans, taking steps to pay off all debt before you retire (including your mortgage), and finding ways to cut back basic expenses. (Do you really need a cellphone and a landline?) With a little creativity and a modest bump to your monthly savings, you might just score that millionaire-style retirement after all.