A Million Bucks May Not Finance Retirement

One million dollars - a big, round, juicy number - is the holy grail for most of us. We figure that, if we can only accumulate a million bucks by the time we retire, we can live in comfort, or, at the very least, in a style similar to what we enjoyed while we worked.

Unfortunately, for many folks, $1 million won’t be enough - by a long shot.

Bernie Wolfe, a veteran certified financial planner ran the figures through his computer and the results were frightening.

Wolfe found that, under a set of reasonable assumptions a $1 million nest egg - plus Social Security - will provide a couple with an annual retirement income of only $31,476 in today’s dollars. After taxes, that could be just $25,000.

Even worse, the income and capital from the $1 million is designed to last only 20 years. Even worse, if you live to 86 or older, you’ll have to rely strictly on Social Security (if it exists).

Not that $31,476 a year is to be scoffed at. Many people can live very well on that amount, especially if they’ve paid off their mortgages. But it’s hardly the sort of money you’d imagine that $1 million would produce. In fact, it’s about 20 percent below the U.S. median family income!

The reason that the figure is so shockingly low can be summed up in one word: inflation. In running the numbers through his computer, Wolfe assumed that consumer prices would rise at 5.5 percent a year. As a result, the buying power of $1 million becomes significantly diminished.

But, even with 3 percent inflation, $1 million won’t leave you rolling in dough. According to Wolfe’s computer, your annual income in retirement will be $65,712.

But Wolfe warns against such a rosy scenario. “I don’t think you can ever put enough money away,” he says. “So I’m sticking to 5.5 percent inflation. I hope that it’s only 3 percent, and I screw up big time and make people put too much away.”

In fact, 5.5 percent inflation might be reasonable. Over the past 10 years, the consumer price index has risen at an average rate of just 3.0 percent, but over a longer period, from 1966 to 1995, it rose at 5.7 percent. From 1976 to 1995, it rose at 5.6 percent.

But before you throw yourself out the window, let’s take a look at the assumptions that Wolfe used and decide if they’re appropriate for you.

His example is a married couple, both spouses now 40 years old and planning to retire at age 65 in the year 2021. If you’re closer to retirement, then $1 million will go further, since inflation has less time to ravage the nest egg.

Next, we assumed that the $1 million is split this way: $750,000 in a tax-deferred retirement account, such as an IRA or 401(k), and $250,000 in a taxable account. We assumed a tax rate of 28 percent (which is the current capital gains rate and the rate on ordinary income for many Americans).

We assumed that the nest egg would produce an annual return of 8.5 percent.

Social Security is trickier. First, we assumed that one spouse would receive the maximum benefit and the other would get half the maximum.

Second, doubtful that Social Security would continue to rise with inflation, Wolfe scaled back the annual cost-of-living increases to a flat 3 percent.

Let’s hone in on Wolfe’s intermediate example, which assumes 4.5 percent inflation. In the first year of retirement, the $1 million nest egg will produce $64,000 in income and Social Security will pay $59,000. (Note that Social Security represents fully half of income!) That’s a total of $123,000 - which sounds, right now, like an awful lot of money. And the total keeps rising, eventually to $284,000 at age 85. But the catch is that $284,000 is worth only $42,852 in today’s money.

But maybe you think that $42,852 a year is all that you and your spouse need - even if your combined income today is $125,000. Don’t kid yourself.

Wolfe says that a good rule of thumb is that, in retirement, you will spend about 75 percent to 80 percent of what you spent while working - and perhaps just 60 percent if you’ve paid off your mortgage.