A million dollars ain’t what it used to be. Especially as a retirement nest egg.
Sure, some of that decline in value can be chalked up to inflation. But inflation is far from the only culprit.
It turns out that while you were busy working, raising children, and going about the everyday bustle, retirement changed dramatically in recent years. You may not be able to count on Social Security income or pensions, and that’s just the start. It says nothing of the growth of the transition to a gig economy short on employer retirement plans, much less pensions.
So how far does $1 million actually take you in retirement? It depends on where you live, your employer benefits, your spending habits, and your investing habits. Starting with a traditional retirement strategy, take the following tour through a seven-figure retirement — and how you can bend the rules to stretch your nest egg further.
Traditional Sources of Retirement Income
When you envision your retirement, you probably think of three potential income sources: Social Security, a pension (if you’re lucky), and your own savings and investments. Here’s how they currently hold up for retirement planning.
Social Security
If you’re under age 50, don’t get too excited about Social Security benefits. For that matter, don’t get too excited even if you’re over 50.
A 2020 analysis by the Senior Citizens’ League found that the buying power of Social Security benefits have fallen 30% since 2000. In lay terms, that means the Social Security Administration has quietly and indirectly reduced benefits by raising them slower than the rate of inflation. The SSA raises benefits through a cost of living adjustment (COLA), which only happens in some years, and has lagged inflation since 2000.
The SSA knows it faces major structural challenges. It will increasingly support a large, aging population of baby boomers drawing benefits, and its 2020 report abbreviated the timeline for the program’s insolvency to the year 2034 — previously pegged at 2035. After that, they will only be able to afford to pay 76% of today’s benefits.
In the wake of the COVID-19 pandemic, even that may prove optimistic. The Congressional Budget Office estimates the SSA will run out of money by 2031 due to both lower payroll tax revenue and a wave of older workers retiring earlier than they had planned. A report by the Bipartisan Policy Center puts the depletion date even earlier at 2028.
All of which is a long way of saying that although you will likely receive some Social Security money each month, you shouldn’t count on it covering your living expenses — which far too many older Americans do. Fully 40% of retirees live on Social Security benefits alone, according to a 2020 report by the National Institute for Retirement Security.
Pensions
If you think Social Security is an endangered species, wait until you see pensions.
Only 12% of private-sector workers participate in a pension plan, according to the Bureau of Labor Statistics (BLS). And even those plans are rapidly disappearing.
With Americans living longer than they did half a century ago, employers simply can’t afford to keep paying ex-employees’ salaries for decades after they retire. The astronomical cost aside, it also represents an unknown, variable expense: ex-workers could kick the bucket tomorrow, or could live for another 40 years after retiring.
To eliminate these long-term, unknown expenses, employers have overwhelmingly turned to a practice called “de-risking.” You might know it as pension buy-outs, where employers offer a one-time, lump sum payment rather than an ongoing pension payment. For employers, it offers a way to convert that expense from variable to fixed — a proposition enticing enough for 86% of pension sponsors to pursue it, according to the Pension Benefit Guaranty Corporation.
Your Nest Egg of Paper Assets
More than ever, Americans must fund their own retirements with savings and investments.
Employers sometimes help with matching contributions, or at least offering access to employer-sponsored accounts like 401(k)s and SIMPLE IRAs, which have higher contribution limits than traditional IRAs. But many Americans such as freelancers and entrepreneurs don’t have access to these accounts, making it harder for the self-employed to plan for retirement.
This is, of course, where your million dollars come into play. But how much retirement income does $1 million in stocks and bonds generate?
It depends on many factors, starting with your withdrawal rate. When you sit down with a financial advisor to discuss retirement, they propose a safe withdrawal rate: the percentage of your nest egg that you can draw in the first year of retirement. From there you simply adjust that annual withdrawal upward slightly each year to adjust for inflation.
The classic safe withdrawal rate is 4%, which historically means your portfolio should last for at least 30 years of retirement. This is often referred to as “the 4% rule.” Depending on how long you want your nest egg to last, you could adjust that rate up or down. If you have $1 million, a 4% withdrawal rate means pulling out $40,000 in your first year of retirement.
If $40,000 per year isn’t exactly the millionaire lifestyle you had envisioned, well, don’t give up just yet.
The Typical Million-Dollar Retirement Income
Say you follow the 4% rule, taking $40,000 per year from your million-dollar nest egg. That comes to $3,333 per month in income.
According to the SSA’s calculator, a 65-year-old who earned $80,000 per year who retires today would collect $1,811 per month in Social Security benefits. Added to your nest egg withdrawals, that puts your combined monthly income at $5,144, or $61,732 per year.
Granted, the farther you are from retirement, the less you can count on today’s Social Security benefit levels. Consider slashing them by 25% to stay on the safe side, or at the very least not adding any extra to account for future inflation.
Add your pension benefits if you’re fortunate enough to have them, and you have a clear picture of what you could expect from a traditional million-dollar retirement. But no one says you have to take the traditional route to and through retirement.
How to Stretch Your Nest Egg — or Retire With Less
How far each saved dollar takes you in retirement ultimately comes down to two factors: your living expenses and your returns (income) on those invested dollars.
Spend less, earn more. It sounds so simple — and it turns out it’s actually not much more complicated than it sounds.
Take a Holistic Approach to Overhauling Your Budget
Entire books have been written about budgeting. But think of the next few paragraphs as a crash course on creative, holistic budgeting.
First, understand that while the little expenses prove easiest to eliminate, they offer the smallest opportunity for savings. Yes, you should consider ditching cable TV and that $5 daily latte. And yes, these little costs can add up to nearly $13,000 per year in simple savings. Get rid of as many as you can.
What really moves the needle though are your top three expenses: housing, transportation, and food. These account for nearly two-thirds of the average American’s household spending, per the BLS. Which means they offer the greatest opportunity to save.
Start cooking at home more, and in particular find ways to eat healthy on a budget. Brainstorm ideas for how you can get rid of at least one car in your household — or better yet, live without a car entirely (I do!). The average car costs $9,282 per year when you add up the car itself, maintenance, gas, parking, insurance, and all the other incidental costs of ownership, according to AAA.
Most of all, spend less on housing. My favorite approach? Live for free by house hacking. Just imagine how much more money you could save pre-retirement if you didn’t have to make a housing payment, and how much less income you’d need in retirement — your life would instantly get much easier.
While you’re at it, consider downsizing. Smaller homes not only cost less to buy or rent, but they also cost less to maintain, clean, heat, cool, light, landscape, and so forth.
If you opt not to house hack, your housing costs ultimately boil down to where you live.
Move Somewhere With a Lower Cost of Living
At the time of this writing, Zillow reports the median home price in San Francisco as $1,447,191. In Tampa, you’d pay roughly one-sixth of that for a median home: $251,387.
That makes an enormous difference to how much retirement income — and therefore savings — you need to build. A 30-year mortgage at 4% interest for $1,447,191 comes to $6,909 per month, not including property taxes and homeowners insurance, which are both far costlier for a property that expensive. The same mortgage for $251,387 comes to $1,200 per month: a savings of $5,709 per month.
If you followed the 4% rule, you would need to save an extra $1,712,700 to generate that much more monthly income.
And if you retire overseas, you can potentially slash your housing payment even deeper.
Cost of living doesn’t just impact housing costs, either. Everything from groceries to restaurant meals and wine to coffee costs less in cheaper markets. Where I live in Brazil, I can order a steak dinner at an upscale restaurant for $15.
Forget your preconceptions, suspend your disbelief, and just consider with an open mind moving to another state or country. Start with these 10 countries where you can live comfortably on $2,000 per month, and send me a postcard when you get there.
Lower Your Taxes in Retirement
The BLS rather conveniently forgets to include income taxes in their breakdown of the average American household’s expenses. So let’s calculate it for them.
They report the average household income as $82,852. A married couple filing jointly would pay $9,807 in federal income taxes, while a single person would pay $14,017. That doesn’t include state or local income taxes, property taxes, sales taxes, excise taxes, or any of the myriad other ways that governments wheedle money out of you.
By living overseas, you can avoid income taxes on the first $107,600 that you earn ($215,200 for married couples) through the foreign earned income exclusion. If it saved you $14,000 per year in total taxes, that would translate to needing $350,000 less in total retirement savings if you follow the 4% rule.
Even moving within the U.S. can save you thousands of dollars in state and local taxes. The state with the highest tax burden, New York, charges nearly two-and-a-half times more in taxes than the state with the lowest tax burden, Alaska. Consider moving to a state with a lower tax burden, which includes income, property, and sales and excise taxes.
You can also lower your taxes in retirement through tax-sheltered accounts. By maxing out your Roth IRA contributions in your working years, and opting for a Roth 401(k) rather than a traditional version, you can reduce the total amount that you need to save for retirement because more of your retirement income will flow to you tax-free.
As a final thought, bear in mind that your tax bill could go up rather than down in retirement. As governments at every level continue to spend more, expect them to raise tax rates and start planning now to prevent your taxes from going up in retirement.
Consider Adding Real Estate to Your Retirement Portfolio
With interest rates expected to remain near zero through 2023 at least, you can’t expect bonds to offer much in the way of income yield. Personally, I don’t consider bonds so much an investment right now as a safe way to avoid inflation while I hold funds earmarked for other investments.
I invest in real estate instead to counterbalance my stock investments.
Real estate comes with a slew of advantages as a retirement investment. To begin with, it generates ongoing income at a high yield, with no need to sell off assets. That changes the entire notion of safe withdrawal rates.
Real estate also protects you from inflation, with its tangibility and inherent demand. And it moves with little correlation to the stock market, providing true diversification in your asset allocation.
You could go out and buy an investment property. But direct real estate investing comes with some high barriers to entry, both financially and in terms of knowledge and skill. Instead, consider other ways to invest in real estate.
You have more options than you may realize to invest in real estate indirectly with small amounts of money. From real estate investment trusts (REITs) to crowdfunding investments like Fundrise and Groundfloor, private notes to private equity funds, you can spread your money among a wide range of real estate investments for maximum diversification.
I’ve invested through three real estate crowdfunding platforms, and have consistently earned 8% to 10% returns. While I started slowly and experimentally with these investments, I’ve gradually ramped them up over time, and with every year that goes by I feel more confident in the reliability of these high-yield returns.
Higher yields from real estate investments reduce the amount of stocks you have to sell to live on in retirement, which changes the amount you need to save for retirement. Still, start small and build your own confidence in real estate investments before relying too heavily on them in your retirement planning.
Consider the FIRE Lifestyle
When people first learn about the FIRE movement to reduce living expenses, increase savings and investments, and reach financial independence to optionally retire early, many scoff. They view it as making “extreme sacrifices” in lifestyle.
It’s the wrong way to frame the conversation. I don’t consider it a sacrifice to give up buying new clothes every month, or monthly massages, or always having the latest model smartphone. I enjoy living in a smaller home that requires almost no upkeep, wearing athletic clothes while I work remotely every day, and walking and biking to get around rather than driving. Most of all, I enjoy building wealth so much faster than the average person, and the fact that in a few short years I’ll be able to cover my living expenses with passive income streams.
Remember, the lower your living expenses, the easier it is to cover them with passive income.
But the benefits don’t end there. The FIRE lifestyle comes with some hidden benefits; for example, it affects the types of insurance that you need. Because our family lives entirely on my wife’s income and we save and invest mine, we don’t feel the need to buy life insurance or long-term disability insurance. If one of us died or had to stop working, the family would carry on financially.
The money we save on these insurance policies goes straight into our investments, compounding our wealth growth even faster.
With low living expenses and a high savings rate, retirement planning goes from distant dream to something near and tangible. That changes how you think about it and how aggressively you pursue it. And it can also empower you to switch to a more sustainable, more fulfilling career.
Explore Meaningful Work for Pre- or Post-Retirement
Far too many people succumb to lifestyle inflation: every time they start earning more, they start spending more.
But if you maintain low living expenses, you not only save money faster, but it frees you to choose lower-pay but higher-meaning jobs — jobs that you would want to continue working long after you’d have quit that high-stress, high-pay job to retire.
Even after I reach financial independence, I plan to continue working and earning active income. Health permitting, I’ll work into my 70s and even 80s, but on my own terms. And that too changes the way I look at retirement.
Because I’ll continue working, I don’t have to worry as much about the size of my nest egg or safe withdrawal rates. My investments will keep growing because I can leave them largely alone as I keep earning money doing work that I’m passionate about.
As you look at the second half of your career, and even at your retirement, consider a retirement-friendly job. The extra income from working longer in a field you love can help you delay taking Social Security — which boosts your monthly benefit — and help stretch your nest egg further by reducing the need to withdraw money from it.
An Alternative Million-Dollar Retirement
Instead of the traditional million-dollar retirement outlined above, consider an alternative that looks a bit more attractive.
Say you’re 65 with $1 million saved. You invest $600,000 of it in a diverse set of index funds. You invest $300,000 in indirect real estate investments earning an 8% yield ($24,000 per year). And you invest $100,000 in government bonds paying 3% ($3,000 per year).
You quit your high-stress job and pick up some passion work paying $40,000 per year. For the next five years, you live on your $40,000 active income plus your $27,000 in yields from real estate and bonds, letting your stocks continue to grow untouched. At an historically average 10% return, your $600,000 in stocks compound to $966,306 over those five years.
At 70, you retire from your passion work to do more traveling. You start taking Social Security benefits at the maximum level, adding $29,868 to your annual income (using the same base income assumption as earlier).
You now also start withdrawing 4% of your stock portfolio, adding $38,652 in annual income. That puts your total annual income from all sources at $95,520, which breaks down to nearly $8,000 per month. And it doesn’t even include you withdrawing any principal from your real estate or bond holdings.
Of course, you don’t have to wait until you have $1 million or reach 65 to quit your high-stress job in exchange for higher-meaning work. Whether you plan to transition next week or next decade, start planning it now. You might just be surprised at how quickly you can realize your ideal life.
Final Word
How much do you need to save for retirement? It depends on your living expenses, your investment returns, and on all of the other factors outlined above.
Start by planning out your living expenses and looking for ways to reduce them in retirement. You can then work backward to determine how much income you need from your investments, and from there, how much you need to invest in order to produce that income.
As you start on your journey toward financial independence and retirement, start tracking three critical numbers every month. Track your net worth, which you can do automatically through free tools like YNAB (You Need A Budget).com. Track your total passive income from investments. And track your FIRE ratio or FI ratio — the percentage of your living expenses that you can cover with your passive income.
When you reach a FIRE ratio of 100%, you can retire, regardless of whether your net worth crosses the seven-digit barrier or not.
Do you think you can retire on $1 million? What are you doing to stretch your retirement dollars further?
