When saving for retirement, $1 million may seem like a good target. After all, being a millionaire is traditionally associated with being wealthy. In reality, $1 million really won't go as far as you think it will -- especially accounting for inflation.
Rather than setting $1 million as a target, it's far better to consider the amount you're actually likely to need in retirement. If you have an idea of that, you can be much more realistic when you invest -- and you'll be more prepared as a senior so you won't have a major budget shortfall.
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A million dollars won't produce a ton of income -- especially with inflation
Traditionally, experts recommended you withdraw around 4% of your retirement nest egg during the first year of retirement and then adjust your withdrawals up for inflation each year. This so-called "4% rule" was supposed to protect you from running out of money.
But with longer life spans, rising healthcare costs, and lower projected returns on investment in the future, there's a very real chance you could run short if you follow this rule. Instead, the Center for Retirement Research advises basing your withdrawals on tables prepared by the IRS for calculating required minimum distributions (RMDs) from 401(k) or IRA accounts.
If you use these tables, you'd withdraw between 3.13% and 3.65% annually from ages 65 to age 70. So, if you had $1 million upon retirement at age 65, you could safely take out around $31,300 during your first year in retirement. This sounds like a lot. And if you're retiring in 2019 with $1 million, it would probably be enough -- especially when combined with Social Security benefits, which average around $1,461 per month.
The problem comes, however, if you're setting that $1 million goal for the future. If you're 10 years away from retiring, $31,300 in today's dollars will be worth only about $23,290 when you hit retirement age (assuming a 3% inflation rate). You'd need $42,064.58 to have the same buying power -- which means you would require about $1.34 million in savings.
And if you're 20 years from retiring, the situation is even worse. Your $1 million would only produce the equivalent of $17,330.05 in income. This isn't nearly sufficient, especially given the very real chance taxes will go up -- and the fact that seniors tend to spend the bulk of their money on housing and healthcare, both of which often experience cost increases that outpace inflation.
While you do get Social Security cost of living adjustments (COLAs), you can't count on Social Security to make up the shortfall. Benefits are losing their buying power thanks to the fact that the index for calculating COLAs doesn't accurately measure increases in the costs of things seniors spend the most on.
How much should you save for retirement?
There are a number of different ways to figure out how much to save for retirement.
One option is to aim to have savings equal to 10 times your final salary. If you take this route, you'll need to estimate what you're likely to make at the time of retirement. Do this by projecting what your future income will be, assuming around a 2% to 3% annual raise.
If you're pretty close to retirement, you could also set a projected budget to see how much income you'll need. Next, determine how much of that money is likely to come from Social Security (you can check your benefits by signing into your Social Security account). Your income from investments needs to make up the difference between the income you'll need and the amount Social Security will provide.
Taking either of these approaches is a much better way to estimate your retirement savings needs. And chances are good you'll find you require much more than $1 million to support yourself in retirement.
Don't count on $1 million being enough
As you can see, saving $1 million for retirement probably won't be sufficient if your retirement goal is a few years into the future. Instead, consider your specific financial situation and set a savings goal that makes sense for you.
