You often hear this amount tossed around as the minimum level of investment assets that you need before you can safely retire. You can also see color coded maps in magazines and on the internet that show how long $1,000,000 will last in every state. So, $1,000,000 must be the magic number, right?
As with many of life’s toughest questions, the answer is, “it depends”. The amount that you need to generate sufficient income during your retirement depends on the following factors: When will you get your last paycheck? How long are you going to live? How much will you spend during retirement? What other sources of income do you have and how reliable are they?
Let’s tackle these in order.
First, when will you collect your last paycheck?
According to the US Census Bureau, the average age of retirement is 63 years old. But, the decision to quit your job and retire isn’t entirely up to you. Will you remain healthy enough to keep working? Are you working for an employer who values your skills and experience? Many companies make a conscious (and barely legal) effort to push more seasoned and expensive employees out the door long before they turn 63.
Next, how long will you live?
The life expectancy of the average American has risen steadily over the last century thanks to advances in medicine. The average American can expect to live to 79 years, but this factors in infant mortality and early deaths of young men caused by car wrecks, drugs and other unfortunate events. But life expectancy increases as you age with a 60-year-old more likely to live to 80 and a 70-year-old more likely to live to 90. On average, women tend to live about 4 years longer than men. So, if you turned fifty this year, your projected life expectancy is 82 if you’re a male and 86 if you’re a female. But keep in mind that these are averages. Your life expectancy is impacted by your lifestyle choices and family history. If you would like a personalized estimate, you can go to https://www.ssa.gov/OACT/population/longevity.html or https://www.livingto100.com/calculator
So, if you are an average American and retire at 63 and live to be 84, that’s 21 years of expenses that need to be covered by social security, pension income, retirement savings and perhaps some part time work.
How much will you spend during retirement?
According to the latest Bureau of Labor Statistics data, which is based on 2016 figures, “older households” — defined as those run by someone 65 and older — spend an average of $45,756 per year, or roughly $3,800 a month. Your actual spending will hinge on several factors: where you choose to live, how healthy you are and how you choose to spend your free time. If your house is paid off by the time you retire and you live in a low tax area, you have an advantage over those living in the Northeast or California. But even if your home is paid off, property taxes, maintenance, utilities and repair expenses remain.
After housing, one of the largest retirement expenditures is health care. Even with Medicare, Fidelity Investments estimates that an average 65-year-old retired couple could spend $11,000 per year on their health care. Unfortunately, health care costs have been rising at a faster pace than general inflation.
Another typical retirement expense and one where you have the most control is hobbies, travel and entertainment. When I ask my clients when they spend the most money, the answer is usually “on the weekend.” Well, when you are retired, every day is the weekend. If your travel plans involve driving to visit your grandkids and spending a few weeks in Florida each year, your spending will probably align with the averages. But, if you dream of spending the entire winter in your second home on the beach or visiting Europe every year, the averages won’t apply. The same goes for your hobbies. Camping, volunteering, hanging out with your friends and entertaining at home will be a lot less expensive than buying a sailboat, dining out every night or becoming a collector of art, cars, watches, etc.
But, for the sake of the argument, let’s assume that you plan to be incredibly average when you retire and need to bring in $45,000 in your first year of retirement. If you have paid FICA taxes for more than ten years or are married to someone who has, you are eligible for social security retirement benefits. Under normal circumstances, you can begin drawing your retirement benefit at age 62, but your benefits increase about 8% for every year you delay up until age 70. To find out what your future benefits will be at age 62, full retirement age of 66 or 67 and at age 70, go to https://www.ssa.gov/benefits/retirement/estimator.html
The average Social Security benefit was $1,413.37 per month in June 2018. The maximum possible Social Security benefit for someone who retires at full retirement age is $2,788 per month in 2018. However, a worker would need to earn the maximum taxable amount, currently $128,400 for 2018, over a 35-year career to get the maximum Social Security payment.
Keep in mind that not even social security benefits are guaranteed to stay at current levels. The latest projection has the combined Social Security trust funds that pay retirement and disability benefits running out of cash reserves by 2034. But that wouldn't leave Social Security bankrupt and unable to pay any benefits. Even if Congress does nothing to shore up the system by 2034, Social Security will be able to pay out 79 percent of promised benefits until 2090. The last time Social Security nearly depleted its reserves was in the early 1980s, when Congress shored up the program by gradually increasing the full retirement age from 65 to 67 and started to tax benefits based on income levels.
For the purposes of our hypothetical average retired couple, let’s assume that both spouses earned enough credits to get the average combined social security benefit of ~$34,000, which is indexed to inflation. Subtracting just our social security income from our expenses leaves a gap of $11,000 in the first year of retirement.
If you are one of the fortunate few who are eligible for a pension, you may very well have enough reliable income to close the gap. In 1960 about half of private sector employees were covered by a defined benefit pension plan. In 1983, there were 175,000 defined benefit plans, but less than 45,000 such plans today. But just because you are covered by a pension, your promised benefits are far from assured. Boston College estimates the nation's 1,400 multi-employer plans (corporate) are facing a $553 billion shortfall. And around one-quarter of those are in the "red zone," meaning they'll likely go broke in the next decade or so.
For those of you who are saying, “But, I have a government pension, so I’ll be OK. “Unfortunately, the news for you isn’t any better. Credit-rating agency Moody’s, reports that state, federal and local government pension plans are also $7 trillion short in funding, which means that your future benefits are at risk.
If you don’t have a pension, any shortfall will need to be covered by cash flow from your savings and investments. If your projected income from all sources is less than your expenses, calculate how much you’ll need in investable assets to generate enough cash to close the spending gap. Use a reasonable withdrawal rate of 3-4%. For example, if your annual shortfall is $20,000, you would need to accumulate between $500,000 and $667,000 in investible assets by the time you retire.
To find out how much you need to save before you retire, this is your action plan:
- Go to https://www.ssa.gov/benefits/retirement/estimator.html and find out what you can expect from social security.
- Create a projection of what you might spend in the year you would like to retire. Be realistic about what expenses might increase and what expenses might go away, like your mortgage, a second car, clothes for work, etc. Be sure to factor in inflation.
- Determine what other sources of income might be available, e.g. a pension or a part time job. You may want to discount any future pension benefits if your plan is significantly underfunded. If you’re not sure, ask your HR department for a copy of the Pension Funding Notice or Form 5500
- Calculate how much you’ll need in investable assets to generate enough cash to close the spending gap.