The $1 million mark has long served as the ultimate retirement account target for many aspiring retirees. Those who manage to stash away seven figures earn millionaire status in addition to feeling as though they will be able to support themselves comfortably throughout their golden years. However, times change, and $1 million no longer stretches as far as it did in the 1980s and '90s.
Is it still possible to retire on $1 million? The answer to that question depends on a number of individual factors that can change over time. We'll help you understand how the purchasing power of your retirement savings can change over time, giving you the information you need to come up with your own magic number. (Learn how the average person can become a millionaire with a little discipline and the help of some powerful savings vehicles in How To Become A Millionaire.)
Will $1 Million Last?
Several factors determine how long your savings will last after you retire. Some are fairly straightforward, while others are less obvious and more difficult to predict. Here are some of the basic questions you should ask yourself when determining the proper retirement savings target for you. (For related reading, see Five Retirement Questions Everyone Must Answer.)
- How much will you need to withdraw every year to support yourself after you retire?
- Are you a lavish spender, or a thrifty bargain hunter?
- Will you have adequate funds for discretionary expenses like vacations?
- Does your health require significant expenditures? (Keep in mind that healthcare costs may increase as you age.)
- What are your expectations for your tax rate throughout your retirement years?
- Do you have a retirement plan that offers tax benefits?
- Unexpected Expenses
- Do you have a financial cushion to cover potentially expensive unexpected events?
- Market Fluctuation
- How will your portfolio returns fare once you retire?
- How much will the purchasing power of your dollars erode over time?
There is a lot to consider when determining how far your retirement account balance will take you, and many answers to these questions are subject to an individual's lifestyle choices or unique circumstances.
Inflation and Purchasing Power
Understanding inflation and its effects on purchasing power may shed some light on how long your retirement funds will last once you retire. Inflation erodes the purchasing power of a dollar, meaning that over time, a dollar buys less because prices climb higher. In extreme cases, an economy may experience hyperinflation, although the U.S. has not experienced hyperinflation in recent memory. (To brush up on the basics of what causes inflation and how it affects your investments and standard of living, check out our tutorial, All About Inflation.)
The following examples illustrate how inflation erodes purchasing power.
- If you purchase a can of soda for $1 this year and then purchase a can of soda next year for $1.05 (same brand, same size), inflation is 5 cents, or 5%, during this one-year period. Because your dollar no longer buys the same amount of goods, you have lost 5 cents worth of purchasing power.
The same principle can be carried over to your $1 million hypothetical retirement account balance. Because prices generally increase over time, your money could buy more 20 years ago, or even 10 years ago, than it could buy today.
The effects of inflation become more noticeable to consumers over time. As such, $1 million could buy even more back in 1980 than it could it 1990 and more in 1990 than in could in 2000. Because inflation can erode your ability to purchase goods and services, it is important to factor inflation into your retirement planning goals: the higher the rate of inflation, the less purchasing power you will have over time.
Purchasing Power in the Future
To see how purchasing power might change in future years, we must make assumptions regarding the future rate of inflation. Government agencies, such as the Bureau of Labor Statistics (BLS), measure inflation using several methods, including the CPI. Annual changes in the CPI can be used to estimate how purchasing power has changed over the past few years. For illustrative purposes, we will use the average annual change in the CPI from 1987 through 2007 - 3.1% - as our "normal" rate of inflation.
Assuming a 3.1% annual rate of inflation, if you had $1 million in 2008, you will only be able to buy $736,908 worth of goods in 2018 (in 2008 dollars). The longer your time horizon, the more pronounced the effects of inflation. That same $1 million from 2008 would only be able to buy $543,034 worth of goods in 2028 (in 2008 dollars). Remember, the rate of inflation varies from year to year, and higher inflation results in lower purchasing power over time. (Learn more about out how inflation relates to your investment portfolio in What You Should Know About Inflation.)
Inflation is an important factor to consider when establishing your retirement targets. Because changes in the world economy or your own individual circumstances can occur at any time, it is important to evaluate your assumptions surrounding your retirement goals on a regular basis (annually, at the very least). Remember - $1 million no longer buys what it did back in 1980, and this magical number will continue to lose its luster over time due to price increases.
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