Becoming a millionaire is often synonymous with becoming rich, but does that mean a $1-million nest egg frees you from financial worries about retirement?
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The answer is: It depends. While $1 million may be enough for some seniors, it could also fall short. A study from Northwestern Mutual found U.S. adults believe they will need $1.46 million in savings to retire comfortably.
Say you’re 58 years old and your retirement account has hit seven figures. You may be tempted to stop saving because of it. But don’t do that until you’ve done the math and considered these important factors that could affect how far your money goes.
How much can you actually spend a year?
The first big thing to realize is that having a $1-million nest egg doesn’t mean you have a million dollars to spend right away. This money must last you for the rest of your life, so you can only use a little bit at a time. Most of it needs to stay invested, continue earning returns, and wait to support you later in life.
One popular guideline says your balanced portfolio will last 30 years if you limit your withdrawals to 4% of your balance in the first year and then adjust your withdrawals to keep pace with inflation. Assuming you follow this rule, $1 million in savings produces $40,000 a year to live on. Now, this will combine with Social Security, but on average Social Security benefits only replace about 40% of pre-retirement income.
Another rule of thumb says you’ll need 80% of your pre-retirement income per year in retirement. Ask yourself if $40,000 is going to be enough to supplement your Social Security benefits, as your withdrawals should ideally replace another 40% of your pre-retirement earnings. If you were making $60,000, you’re in great shape. If you were making $150,000, you would fall short.
Read more: Rich, young Americans are ditching the stormy stock market — here are the alternative assets they’re banking on instead
How will inflation affect your spending power?
There’s also another very important — and often overlooked — factor to consider: inflation. Inflation has hit hard in recent years, sending prices skyrocketing. Still, while post-COVID inflation surges aren’t common, prices are always going to go up over time.
The $1 million you have today won’t provide $1 million in buying power years from now. Assuming a 2% inflation rate, in 10 years, it will have the buying power of just $820,348.
That’s why it’s important to have your nest egg invested in assets that will grow in value at the same rate as or faster than inflation.
Your money will keep growing — and you should keep investing
The good news is your $1 million probably isn’t going to be worth just a million if you’re not retiring for a while.
If you’re 58 and planning to retire at 68, Investor.gov’s calculator shows your nest egg should grow to around $1,967,000, assuming a 7% average annual rate of return, which is reasonable to expect if you have a balanced portfolio. According to Morgan Stanley, a 60/40 portfolio defined as a mix of 60% U.S. equities and 40% U.S. Treasury bonds has a historical annual median return of 7.8%. If you follow the 4% rule, this will produce closer to $80,000 a year in retirement income, which you may decide is enough.
However, unless you have a good reason to, you should not stop investing entirely — especially if you’re planning to retire younger. These are prime investing years when you qualify for catch-up contributions. Plus, if your employer offers a 401(k) match, they give you free money just to contribute to your account. There’s no reason to pass that up.
The bottom line is that your $1 million should stay invested in a good mix of equities along with some conservative investments. If it does, you’ll most likely be fine, depending on your goals, as long as retirement is still a ways away. However, you should keep investing at least enough to earn your employer match, and more if you can comfortably do so, to ensure you have the funds you need for your dream retirement.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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