Saving $1 million may sound like a good retirement goal. And you may assume a seven-figure nest egg would give you plenty of income to enjoy your later years.
The reality, however, is that $1 million in your retirement portfolio may not provide nearly as much money as you think. Here's the reality of just how much you can do with it.
Why a $1 million nest egg doesn't go as far as you might think
While a nest egg valued at $1 million may sound like a lot, you need to keep a few things in mind:
- If you withdraw too much from your investment accounts, you could end up with an account balance that's too small to earn many returns, and that puts you at risk of running out of money.
- Taxes could reduce the actual amount you have to spend after you've taken withdrawals from your retirement accounts.
- Inflation will reduce your buying power as prices go up over time.
To avoid withdrawing too much from your accounts, you should decide on a safe withdrawal rate. That's the amount of money you can safely take out without risking your savings running dry while you're still alive. Traditionally, experts recommended a 4% withdrawal rate in your first year, which could be adjusted up by inflation each year. Because of longer life spans and lower future projected returns, this may be a bit too aggressive if you want to be sure you won't fall short. You may want to opt for 3.5% instead.
That means a $1 million nest egg would leave you with around $35,000 or $40,000 in annual income at most. When combined with Social Security, that may seem like enough. But don't forget to factor in state and federal taxes. You won't get to keep all your money because of your obligations to the government, and the exact amount you'll end up bringing home depends on a huge number of factors including your filing status, the deductions you're eligible to claim, and where you live. But you'll likely lose thousands to the IRS and your state.
You should also think about what inflation will do to your buying power. If you're planning to save $1 million for a retirement that's 20 years away, a $35,000 income from your investments in the future isn't going to buy you what a $35,000 income would pay for today. The price of goods and services will be much higher by that time, so your $35,000 might have only around $23,000 in buying power, assuming 2% annual inflation over time.
All of this means your $1 million, which sounds like plenty, may not be enough. To make sure you don't find yourself falling short, don't assume a big number like $1 million will be sufficient to support you. Instead, set a personalized savings goal by taking into account your future spending needs, as well as the impact of taxes and inflation, to ensure you have enough to live on in your later years.