Even though $1 million may not go as far these days as it used to, it's nevertheless more than enough to cover the average American's expenses in retirement.
The average cost of retirement
Every year, the U.S. Bureau of Labor Statistics conducts a survey of Americans' spending habits. Its latest, released at the beginning of last month, delves not only into how people spend their money, but also how those habits evolve over time.
Prior to retirement, for instance, the BLS's data show that the average American spends roughly $18,200 a year on housing-related expenses. These include rent and mortgage expenses, property taxes, repairs and maintenance, and utilities, along with a host of other variables.
But once the typical person passes the tender age of 65, their total housing-related expenditures drop to $14,570. There are a number of reasons for this, but the biggest is peoples' tendency to pay off their mortgage during their working years.
Factoring in Social Security benefits
According to the BLS, the typical retiree spent a total of $44,557 in the 12 months from July 2013 through June 2014. After housing, the biggest categories of expenses were transportation, healthcare, and food, which account for a cumulative annual outlay of $17,500.
At first glance, the total amount of expenses seems to be the only number a person needs in order to calculate how much to save for retirement. However, it's important to keep in mind that a portion of your expenses are likely to be covered by Social Security.
The Social Security Administration recently said the average person receives $1,286 a month in benefits. On an annual basis, that equates to a total of $15,432. By subtracting these payments from the average American's yearly expenses, this means the typical person has to cover $29,125 of retirement costs each year out of their own pocket.
Using the 4% rule
It's from this number that we can determine if $1 million is a large enough nest egg to see most people through retirement.
To do this, we use the so-called 4% rule, which holds that a person can withdraw 4% of the original balance of her retirement savings each year for three decades without having to fear it will run out.
Let's say, for example, that you have $500,000 saved in a retirement account when you turn 65. According to the 4% rule, you could safely withdraw $20,000 every year and still have enough to cover your expenses until you turn 95.
But while the 4% rule is usually used to determine how much a person can spend each year based off how much he saved, it also works in reverse. That is, by starting with your estimated expenses, you can use this rule of thumb to figure out how much you'll need to save in order to cover these costs throughout your golden years.
You do this my multiplying your estimated expenses, less your annual Social Security benefits, by the number 25. Based off the $29,125 figure from above, this gives us a retirement number of $728,125.
Thus, at least according to the BLS's data on average expenses in retirement, a $1 million nest egg, supplemented by Social Security benefits, does indeed seem to be more than enough to cover the average American's expenses in retirement.
