The $2.5 Million Retirement Question Every Gen Xer Needs to Answer

Just how much will you need to retire?

Michael Douglass
Michael Douglass
Aug 6, 2018 at 8:32AM
Investment Planning

Ever wondered how much money you'll need to retire?

Prudential recently asked that question of hundreds of workers in Generation X as part of a retirement preparedness study. The average estimate? A cool $2.5 million in savings.

That number will inevitably be a little inaccurate. (It's an average. And, of course, predicting things 20 years out from retirement isn't a precise science.) But whether it's pretty close is a question you absolutely need to ask yourself. Personally, I think it probably is. Here's why.

White compass with green text "retirement" and a green dial pointing toward the text

Image source: Getty Images.

Working the math

I understand that $2.5 million may seem like a lot of (too much?) money. But let's step back and consider the inputs that could get us to that number.

First, there's inflation. Over the past 25 years, inflation here in the U.S. has averaged about 2.5% annually, which is low by historical standards (remember when the rate climbed over 14% in 1980?). It's possible that 2% annual inflation could be the new "normal" given our economy's general slow growth. It's also distinctly possible that we'll return to 4% or even 5% inflation simply by reverting to the mean. And if major inflationary events occur (think another oil embargo or a trade war), things could ratchet even higher. If you're 20-ish years away from retirement as a member of Gen X, here's how much money you'll need to buy something that currently costs a dollar:

Annual inflation for the next 20 years To purchase something that costs a dollar today, you'd need... $2.5 million at retirement would be equivalent to...
2.5% $1.64 $1.5 million
4% $2.19 $1.1 million
5% $2.65 $940,000

Data source: Calculations by author, using SmartAsset's inflation calculator. Numbers are rounded.

In 20 years, $2.5 million could purchase less than a million bucks can today. Of course, it's tough to predict these things with any accuracy.

Calculating budgets with the 4% retirement rule

Even so, $2.5 million (even if it only purchases the equivalent of what $1.5 million -- or even just a million dollars -- can buy today) seems like an awful lot of cash to fund your retirement. That's until you consider how long retirement can run. The 4% retirement rule dictates that you can withdraw 4% of your total assets in the first year of retirement, and track inflation after that. So if you have $1.5 million saved, you could spend $100,000 in year one, $104,000 in year two if inflation is at 4%, and so on.

The 4% retirement rule assumes that you're willing to draw down all of your assets in 25 years. Actuarial tables from the Social Security Administration indicate that today's Gen X workers will have, on average, between 18 and 23 years to live when they turn 65, so the 4% rule could work for the average Gen Xer. Of course, you may want to have some extra cash around because you may live a good bit longer than that -- remember that people are generally living longer than they used to, and that there could always be a new medical breakthrough that further extends life expectancy.

Also, you'll have the opportunity to take Social Security around the time you retire (as early as age 62 for a reduced payout, or as late as age 70 for a significantly boosted one). The current average Social Security check is good for about $17,000 annually, and given that the Social Security Administration boosts payouts to keep up with inflation, let's assume for purposes of this example that Social Security's payout retains its purchasing power.

The chart below shows what $2.5 million, withdrawn at 4% annually, would purchase (in today's dollars) in 20 years, assuming Social Security keeps pace with inflation:

Annual inflation for the next 20 years 4% withdrawal purchasing power in today's dollars Social Security purchasing power in today's dollars Total income
2.5% $61,000 $17,000 $78,000
4% $46,000 $17,000 $63,000
5% $38,000 $17,000 $55,000

Data source: Calculations by author. Numbers are rounded.

It's not really that much money on a yearly basis, particularly if annual inflation creeps up.

A few puts and takes

Of course, there are reasons to think that your spending in retirement may go down. You could move to a lower-cost area, and you won't have to pay for your commute to work anymore. You'll no longer be socking away money for retirement, and hopefully your house will be paid off, along with any other debt (although there are worrying statistics showing seniors' debt burdens gradually growing).

On the flip side, healthcare expenses will almost certainly spike in retirement. And you may have plans for your golden years -- plans to travel, to spoil your grandkids, and a million other things. All of this is to say: That $2.5 million isn't really an outlandish amount to need to save for retirement.

How to get there

The beauty of being 20 years out from retirement is that you still have plenty of time to make the power of compounding work for you. The stock market has historically returned around 7% annually after inflation, and 20 years gives you time to quadruple your money (again, even after accounting for inflation) if those historical numbers hold into the future.

Plus, chances are good that you have access to a variety of attractive retirement accounts, all of which offer fantastic tax benefits. Most 401(k)s come with a company match, which is free money to entice you to save for retirement. IRAs, of course, allow you to get a little fancier in your tax planning (personally, I prefer Roth IRAs, although there's a good argument to be made for traditional IRAs). And a Health Savings Account (HSA) has some unique attributes that make it an excellent retirement-savings vehicle.

Consider just how much you're going to need to have saved for retirement, based on various interest and spending scenarios -- and then make the size of your investments proportional to your need. There's still time to put together the retirement of your dreams.