When people are asked how much they want to save for retirement, the most common answer is $1 million. However, most who say this don't know how much they need to save to reach this goal. Here's a quick guide to help make your million-dollar savings plan, with a calculator that can do the math for you.
The earlier you start, the easier it is
The most obvious factor in determining how much you need to save is your age and when you want to reach $1 million in savings. This is best illustrated with an example.
Let's say that you're 25 years old and want to be a millionaire by age 60. Assuming 8% annualized investment returns (more on that shortly), you could reach that goal by saving $5,373 per year, or just under $450 per month.
On the other hand, if you wait just five years until you're 30 to get started, the savings requirement jumps by more than 50% to $8,174 per year ($681 per month).
How much can you expect from your investments?
To be perfectly clear, there's no way to know for certain how your investments will perform over time. However, we can use historical averages to make predictions. For certain types of investments, here are the historical average returns, which can vary slightly depending on the source and exact time frame used to calculate them:
Historical Average Return (Per Year)
Bonds (fixed income)
Most investment portfolios should have a mix of stocks (or stock-based funds) and bond investments, and here's a quick primer on asset allocation that can help you determine a good mix for you.
Taxable vs. non-taxable accounts
Another important factor in how long it will take you to become a millionaire is whether you're saving in a taxable brokerage account or a non-taxable account like an IRA. If you invest your money in a taxable account, you'll have to pay tax on the dividends you receive from your investments, as well as capital gains taxes when you sell an investment at a profit. These taxes can take a huge bite out of your investment returns over time.
As an example, let's say that you're 30 and want to have $1 million in savings by age 60. Based on a relatively low 15% overall tax rate on investment gains and dividends, you can save $10,275 per year and reasonably expect to meet your goal. On the other hand, by using a tax-deferred or tax-free account, you would only need to save $8,174 per year -- and you might get some nice tax breaks along the way.
In other words, by taking advantage of the tax-advantaged investment options available to you, you can become a millionaire with 20% less monthly savings. This is why I strongly suggest using an IRA or other tax-advantaged option when pursuing a long-term savings goal.
The "millionaire calculator" and how to use it
To help you determine your millionaire number, here's a calculator that can determine how much you should plan on saving per year.
A few notes on using the calculator that can help maximize its usefulness, in order of importance:
- Use realistic investment returns. The historical numbers I discussed in the first section are fine, and it's always best to err on the side of caution. For example, if you plan on investing in a portfolio of mostly stocks with some bonds mixed in, an 8% average annual return is reasonable. Ten to 12 percent? Not so much. If it happens, great, but my point is that you shouldn't expect it.
- While the calculator has a spot for your marginal tax bracket, it's important to point out that taxes on most dividends and capital gains are lower than these rates (15% for most income levels). Therefore, I'd suggest using 15% for the tax rate if you invest in a taxable account and 0% if you invest in an IRA or other tax-advantaged account.
- Notice that the calculator has an input field for anticipated inflation. The 3% default value is a reasonable expectation, and is close to the long-term average. The point of this is that $1 million in a few decades won't be worth what $1 million is worth today.
So, the calculator will give you two numbers once you enter your data. The first is the amount you'll have to save to get to $1 million. The second is the amount you'll have to save to get an inflation-adjusted equivalent of $1 million, which is a much more ambitious target.
The bottom line
As a final thought, it's important to remind you that $1 million (or even its inflation-adjusted equivalent) may or may not be enough to provide for your retirement income needs. After all, most experts suggest that you should only plan to withdraw 4% of your savings each year to make sure they last throughout your retirement -- this translates to $40,000 in annual income on a million-dollar nest egg. Here's a discussion of how you can find your own retirement number so you can adjust your savings plan accordingly.