Who would like to have a million dollars? I’m assuming everyone raised their hands. If you had a million dollars in the bank, would you march in and quit your job? Perhaps fewer of you agreed with that statement. Let’s look at the question at hand about whether a million dollars in the bank means that you can retire (stop working altogether) and live off of those funds for the remainder of your years.
There was a time not too long ago where if you had a million dollars, you were set. You could live on the proverbial “Easy Street” and not have to worry about money any more. And to make it all sound even better, you could refer to yourself as a Millionaire, which in our US vocabulary carries with it a host of positive connotations. Make no mistake about it, a million dollars is still a lot of money, but is it still the pinnacle of wealth accumulation and does it set you on a path of instant and secure retirement? As you might imagine, there is not a black and white answer for this question. For some people the answer could still be “yes” and for others the answer would be “no” and they would require more money. Let’s look at four main variables which could influence your answer to this question.
For the sake of this post, let’s use a fairly well used rule of thumb on investment drawdowns which purports that if you withdraw 4% of your balance each year, the odds of your money lasting you until you die are incredibly high. There is a lot of data and analysis behind this rule of thumb which we might dive into in another post, but for now let’s just utilize it in our discussions. Rules of thumb are not a good way to base your entire portfolio management on, but for high level discussions and trends, this one can be quite helpful.
On a common sense level, we would all agree that if you spend $100,000 per year, the infamous million dollars won’t last as long as if you only spend $40,000 per year. But if you step back and utilize the 4% drawdown rule of thumb, then we would see that if you would like to live off of $100,000 per year, it is 4% of $2,500,000 and the $40,000 is 4% of $1,000,000. So, if you are comfortable living off of $40,000 per year, then your answer might indeed be “yes”, you could retire off of $1,000,000.
The reverse math to the 4% rule can be used as a guide to determine how much you might require in savings to be able to retire comfortably assuming a given income each year. For this, you take the annual income you desire and multiply it by 25.
$40,000/yr x 25 = $1,000,000 in savings
$75,000/yr x 25 = $1,875,000 in savings
$125,000/yr x 25 = $3,125,000 in savings
You can play around with various income levels to obtain a general level of savings you might require in order to live at that level in retirement.
Other Income Sources
Hopefully you will not have to rely completely on money from your savings once you retire. Many people will have income available from Social Security, pensions, annuities, or part-time work. So, if your annual expenses are $50,000 per year and you have $10,000 per year in income from these various sources, then you’re actual drawdown from your savings would be closer to $40,000 per year which could indeed put you at the point where $1,000,000 would be sufficient for you to retire. Granted, if you are using part-time work to supplement your annual income, it may not be an option as you get much older, but those are some of the multitude of variables that can be discussed with you financial planner.
Years of Retirement
You can probably estimate much better toward how much money you will need each year than you can estimate how many years you’ll live. If you actually knew how long you would live, then you would be able to make much clearer decisions in all aspects of your life. Unfortunately we know that is not the case and none of us have that crystal ball to know when we will breath our last breath.
If you keep yourself in good health and have a family history of long lives upwards of 80, 90, or 100 years, then you might want to give serious consideration to the concept that you might need your money to last you that long. The opposite is also true. If you received the horrible news from your doctor that you will not likely live for more than another year, then the way you spend or save money would also drastically change and you might not need it to last for 30+ years.
A concept that I had to get my mind around was the fact that I’m planning on being retired for more years than I was working. How is that even possible? Well, as we’ve discussed in other posts, your savings rate is the key factor and then also the rate of return you get on your investments also plays a role. But it is indeed entirely possible that you would be living off of your retirement savings for longer than you actually worked, especially if you subscribe to the tenants of the financial independence/early retirement groups. But realistically for a lot of people, they may work full time for 30-40 years and then live off their retirement savings for 10-20 years, which is also not a bad way to go.
Return on Investments
As you might imagine, if you are consistently generating returns of less than 4% per year and you are drawing down 4%, the math is going to tip against you at some point. Rules of thumb such as this one are based on averages over many years and returns can fluctuate below the average and hopefully above the average too. So, if you have found a consistent investment that returns 10%, then perhaps you can draw down more than 4% per year. Those are very hard to come by, but also be mindful that if you want a safe investment return and chose a CD that is only returning 1-2% return, then the 4% drawdown will start to drastically reduce how long your retirement savings will be able to last you and perhaps the $1,000,000 won’t last as long as you hoped.
One point that I probably should have stressed in the beginning is that you definitely have to keep earning returns on whatever savings/nest egg you have. I think there is a misconception in our US culture that thinks you can just keep a large sum of money stashed away and draw it down over time. You could do that, but it will last far less time before you are completely out of money. A diversified investment scheme is still required when you retire. Granted, your approach to aggressive vs. conservative investments will likely change, but you definitely have to stay invested to keep generating returns and using compound interest in your favor to have more you can draw down over time.
What is Your Answer Now?
Has your answer changed from when you first read the post? Do you think you could live off of $1,000,000 in retirement? For my family, our answer is “no” we could not retire off of $1,000,000 and not work again while maintaining the level of expenses we would like to support our chosen lifestyle. That’s our story, but you may be able to comfortably support your lifestyle with less than $1,000,000. Or may have more expenses than our family and need to have more saved up. There is no wrong answer to this question.
I hope this post does not discourage you, but rather encourage you to start thinking and working on all the variables at play that can affect how much you might need to retire. If there was only one variable that could make all the difference, then financial planning would be easy. It is not though, but with some logical thought, analysis and modification of these (and other) variables, as well as regular discussion with a financial professional, you can get to the place where you are comfortable with the magic dollar amount you’ll need to retire.