Covid-19 has many things to answer for, and here’s another: the stress it is causing with regard to retirement savings. Saving enough money from monthly income for a comfortable retirement income is always a major source of financial stress, but the percentage of those worrying about an inadequate pension fund has risen due to the pandemic.
In May and June 2020, Charles Schwab conducted a survey in the U.S. asking 1,000 employed Americans who are already saving into company-sponsored retirement plans how much money they thought they would need to save to retire comfortably. At least 86% of participants said they likely needed $1.9 million to retire comfortably.
In comparison, a Charles Schwab survey conducted in 2019 found that 74% of people needed at least $1.7 million to live comfortably after retirement. For millennials, the figure needed to retire comfortably was $2 million.
With the goal of saving $2 million and a pandemic throwing a spanner in the works, it is perhaps not surprising that 14% of those interviewed feel that this figure is unattainable, while 21% expect to retire later than they originally planned and 12% have increased their contribution rates.
Maybe you think that $2 million sounds excessive, but many financial advisors would argue it really isn’t as much as you think. Why?
One reason is that people make so many assumptions about retirement income which are false.
- They assume their expenses will fall after they hit full retirement age – this is often not the case as retirement spending often exceeds the expected amount.
- They work on a particular rate of return which turns out to be false – nothing is guaranteed.
- They think social security benefits or services will fill the gap – they won’t.
- They underestimate how long they will need their pension or retirement fund to last – life expectancy has been rising steadily for a while. The number of centenarians in the U.S. rose by 44% between 2000 and 2014.
- They fail to take inflation, taxes and investment risk into consideration in their retirement planning.
Let’s talk about inflation because it is so often neglected in retirement planning in spite of the massive influence it can have on the value of our personal finance, income streams and savings.
Inflation causes the value of money to fall as prices increase and therefore reduces its buying power. It’s most easily explained by using an example.
If a loaf of bread costs $1 at the beginning of the year and the inflation rate is 5%, the loaf of bread will cost $1.05 at the end of the year.
Although 5 cents sounds like nothing, if you scale that up over lots of different items and over many years, the effect on your spending power can be devastating.
So let’s say you think $2 million is excessive, and you believe you could happily retire on a more modest sum of $750,000. You need to consider the effect of inflation on $750,000 in today’s money and what it will be worth when you retire. Of course, that depends on how far from retirement age you actually are.
If you are nearing full retirement age, $750,000 could be enough for you, depending on personal data, such as the kind of life you are expecting to live in your golden years. However, bear in mind that when you started saving 40 or so years ago, $750,000 would have had much greater spending power. To give an example, if we take the year 1980 as a base, $750,000 would have been worth around $2.5 million in today’s money, according to this nifty calculator from the U.S. Bureau of Labor Statistics.
And that’s what those who still have a long way to go until retirement need to bear in mind. Someone in their mid to late 20s will most likely have 40 or so years left until retirement. By 2060, if we take an average annual inflation rate of 3%, $750,000 in today’s money will be nearly $2.5 million.
You can play around with different figures using an inflation calculator, but the overall takeaway will be the same – inflation is going to diminish your future buying power, and you will need a bigger total savings pot than you think.
The continuous decrease in the value of money over time is one reason why it is so important to invest your savings carefully. You need to ensure that your retirement fund is outpacing inflation to avoid its value from falling in real terms. It is also advisable to get assistance from a registered investment adviser or certified financial planner to help you with your savings goal.
The stock market is feared by many, but it remains one of the most effective tools out there that provide services to build wealth without relying on something like monthly income or social security income. It certainly isn’t risk-free, but what is? And if you look back over history, holding stocks over the long haul (more than a decade) has always delivered capital growth. Here’s a graph breaking down stock market returns into 40-year time frames – all of them demonstrating exponential growth.
Staying ahead of inflation means you’ll have to invest. The stock market continues to provide the best means for investors to earn a long-term return on invested money, but it always comes with risk.
The most consequential risk is arguably the timing of retirement. The year in which you choose to retire significantly impacts your cash flow situation during retirement. For instance, those that retired back in 2007 saw their nest egg reduced by over 30% due to the 2008 recession. Conversely, those that retired during the golden ages of the world economy enjoyed a much more comfortable retirement.
The unpredictable nature of the stock market makes it difficult to execute thorough planning, but in-depth research on past performance and trends could potentially protect your money from massive blows.
The best way to ensure your chances of having a sufficient income in retirement is by having a long-term, low-cost investing approach. There are many ways to do this, but the most affordable and straightforward means is likely index funds.
Moreover, it is essential that you rebalance your portfolio every year to ensure appropriate asset allocation for your age and risk tolerance.
The answer to the question: is $2 million enough to retire would differ for everyone. For some, $2 million dollars will allow them to receive a sufficient retirement income to live comfortably and cover their living expenses stress-free.
However, for others, a $2 million dollar amount will fall short by a long shot. Your required monthly income will depend on your personal situation and the purchasing power you are used to having.
Research determined that one of the greatest concerns among new retirees and pre-retirees is the fear of living longer than their retirement savings accounts for.
Even the most rigorous planners face challenges when trying to make a 2 million dollars last throughout their whole retirement.
At age 60, ensuring that 2 million dollars are enough to retire is even more crucial because of the ever-increasing life expectancy. With advancements in health care and medical technology, it is advised to plan for at least 30 years of sustainable retirement income.
Furthermore, consider that social security benefits may only account for 20 to 40% of your retirement income. Many retirees only take social security at age 70, so they can maximise the benefits they will receive.
This is a wise move, but it means that your guaranteed income from your 2 million dollars total will be much higher in your sixties than in your seventies when you start relying on social security.
While it may seem like a large amount, is $2 million enough to retire? Different scenarios will come into play, and you will likely have various challenges in retirement to ensure your money secures your personal finance for the rest of your life.
To project how much income you’ll need during retirement, many financial planners use a retirement calculator called the Monte Carlo Simulation. This calculator does a great job at predicting how much income one needs to achieve a high probability of money lasting through retirement.
This calculator works by considering thousands of stock market return results by changing variables in the simulation. The result it yields is a number that represents the probability that 2 million dollars will last in your retirement.
Based on the probability results, you can decide on the best course of action and evaluate whether your annual pre-retirement income will be able to equip you with an adequate retirement plan.
Beyond the results that Monte Carlo provides, you need to consider the following factors to determine if $2 million is enough to retire by age sixty or if you will need more money to ensure your financial wellness.
- The current and expected growth rate on your money and other investments.
- The monthly income you’ll need.
- Your average life expectancy after retirement.
- Other expenses include health care expenses, car payments, vacations, and other miscellaneous expenses.
A survey performed by Schwab Retirement Plan Services in 2020 determined that an average of 401 000 participants predicted that they would need $1.9 million to retire. This average displays an increase of 12% compared to the previous year.
However, most people in the U.S. are not investing enough or making the right investments to achieve that savings goal and the guaranteed income it entails. The surest way of calculating whether your retirement income is sufficient or if you need more money is by establishing an estimate of all your expenses in retirement.
It’s hard to predict the expenses you may have in the future, but the closer you are to retirement age, the better idea you likely have regarding how much income will be sufficient to support your lifestyle.
Using that amount as a baseline, subtract the expenses you predict to be irrelevant once you retire and add all additional expenses. Remember to consider any potential large expenses as well as cost-savers, like downsizing your home.
Your rate of cash withdrawal plays a vital role in retirement planning. This rate represents the percentage portion of your total portfolio you will be withdrawing annually to cover your living expenses.
- Your retirement lifestyle
- The age of retirement
- Any additional income sources
If you are worried that you are not on track for a comfortable retirement, now is the time to act. Why not make an appointment with me, your financial advisor, to look at your situation and work out a strategy to help sort out your personal data and get you where you want to be? I can help you work out realistic savings goals and recommend investment products which can maximise your capital growth, however long you have left until retirement.
Contact me today at email@example.com for a review.
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