Retirement can seem both exciting and daunting. Exciting, because you are no longer tethered to a job, so you can do all the things you’ve always dreamed of–travel, play golf, or just spoil the grandchildren. But it’s daunting, too, because you’ll need to fund these dreams with the money you’ve saved up during your working years, with a little help from Social Security and, if you’re lucky, the increasingly rare pension.
So, exactly how much money do you need to have saved? Can a couple retire with $2 million? Here’s what you need to know.
How Much Money Do You Need To Retire?
Reasonably? The amount of money you need to retire depends on three things: how long you live, how much you spend, and what you earn on your investments. Take a look at each of these three things.
1. Life Expectancy
This is the retirement wild card. No one knows how long they will live, but you may have some indications. If your health is good and you are active and happy at age 65, you could live another 30 years or longer, so you should plan for that. Also, consider your family history. If you have parents who lived into their 90s, it’s likely you will live at least that long as well.
This is not to say that if you don’t have longevity in your family or you have health issues at 65, you don’t have to watch your retirement spending. There’s just no way to predict how long you will live, so err on the side of caution and assume a long life.
2. Spending Habits and Expenses
Spending in retirement is the thing that you have the most control over. However, there are some things you should keep in mind.
Entering retirement with no debt will help you tremendously. If you have your mortgage paid off, and no car loans or credit card debt, you will have more money to spend on the things that bring you joy in your golden years. You will also have more flexibility when unexpected expenses, like medical costs, come up, as they inevitably will.
Speaking of medical costs, these can become significant the older you get. Having good insurance, including a Medicare supplement and long-term care coverage, can prevent unforeseen medical expenses from wiping out your retirement savings.
Retirees often speak of being on a ‘fixed income,’ which may be true if your only income source is Social Security or a pension. But if you have retirement savings that will be used for income, you have some discretion in how much you spend.
As with life expectancy, you’d need a crystal ball to know how much your investments will earn in the future. It’s best to be conservative here and assume that you’ll earn less than the average stock market return on your investments. One reason is that your portfolio is likely less aggressive than, say, the Dow Jones Industrial Average or the S&P 500, as it should be. So your returns will be less – but your losses will be less in down years as well.
There’s another important factor to consider when you are estimating your returns and you are withdrawing funds at the same time. That is the sequence of returns.
3. Sequence of Returns
The biggest risk to funding your retirement is a concept known as the sequence of returns. The rate of return you get on your investments evens out over time as you are saving for retirement. Once you retire and begin withdrawing your funds, however, the return in each individual year can make a big difference.
Suppose you have a $2 million portfolio. You retire at age 65. Over the next 10 years, your annual rate of return will determine how much money you still have at age 75. If the first few years of your retirement are down years for the market, you’ll have a lot less money than if those years are up, even if your average rate of return is the same.
The chart below assumes a $2 million portfolio, with withdrawals of $100,000 per year. The average return in both scenarios is identical, but the order is different.
In the first example, there are higher returns in the early years.
The second example has the returns reversed in order, so the higher returns come at the end.
As you can see, the account balance is significantly lower after ten years in the second scenario because returns were lower in the early years. Had the first few years seen negative returns, the balance would be even lower.
Retiring On $2 Million
Asking if a couple can retire on $2 million is a little bit like asking how long it will take to paint a house when you’ve never seen the house. There are a lot of variables involved, but a $2 million nest egg should suffice for most couples if they keep an eye on spending and understand how their investments can affect the outcome.