Saving One Million Dollars for Retirement
by Ryan W. Smith
One million dollars is the median savings required for successful retirement, according to results from the Transamerica Center for Retirement Studies 16th annual survey on retirement attitudes, the longest-running survey of its kind.
Getting to that number is not easy, however. A 2014 Government Accountability Office report showed that 630,000 IRAs have balances over $1 million, a small number considering there are over 250 million working age people in the U.S. Likewise, Fidelity Investments said that approximately 72,000 individuals in its 401(k) database had accounts valued over $1 million.
It is important to note that these individuals were lucky enough to invest in markets where investment returns were generally high. Between 1926 and 2014, large company stocks rose an annualized average of 10.1% while medium-term government bonds returned about 5.3%, according to the Ibbotson 2015 Yearbook. In the 1990s, returns were about 18% for stocks and 7% for bonds, helping investments balloon despite the troubles of 2000 and 2008.
However, many economic forecasts are showing lower future gains with a lower interest rate environment and stock markets near all-time highs. Some analysts believe that stocks will produce about 7% returns annualized gong forward, while bonds will return about 4%. It is much more difficult to get to $1 million with these lower returns.
Here is a Finance 101 example for illustration purposes. If you save $1,000 a month, earning 7.5% in annualized returns, assuming a 70-30 stocks and bonds split, with about 1% in annual expenses, it will take you 27 years to get to $1 million. If that return drops to 5%, it will take about 33 years.
Given the degree of difficulty, here are a couple of things investors can do to help get closer to the magical, $1 million median for successful retirement savings:
1) Save as early as possible and save as long as possible
Even in the example above, it would take a sizeable monthly savings, every month for multiple decades, to get to the $1 million mark. Starting to save early in one’s working life helps ensure that savings have adequate time to accumulate compounded interest. Likewise, saving an extra few years just before retirement can help protect one’s nest egg.
A good example of this is to imagine a 25 year-old earning $40,000 a year. If she gets annual raises of 2%, for cost of living, and earns 5% return on her savings after expenses, she would need to save 15% of her annual salary to achieve a $1 million account by age 65. If she did not start saving until age 30, she would need to save nearly 20% of her salary. At age 35, it would be 24%, almost one-quarter of her salary and at age 40, more than 30%.
To show the benefits of continuing to save closer to retirement, imagine our 40 year-old who needs to start saving. If saving for retirement only from age 40 to 65, nearly 30% of her salary would need to be saved. However, if she saved until age 70, that number drops to 22% savings per year.
An added benefit of saving for additional years is that Social Security benefits increase if not taken right at 65. Typically, a 70 year-old drawing Social Security for the first time will receive about 115% of the monthly amount they would have received if payout started on their 65th birthdays.
2) Take advantage of every savings opportunity
The easiest way to do this is to fully utilize employer matching on 401(k) contributions. The most common match available in the U.S. is a 50% match on up to 6% of employee pay, in reality, a 3% match. For our previously mentioned 25-year old with a $40,000 per year salary, with a 3% 401(k) match she would only need to save 16% of her salary per year to reach $1 million by age 65, even if she waited to age 30 to start.
Many people are also not aware that individuals with a 401(k) are also eligible to contribute to IRAs. If one invests $3000, out of a maximum $5500, every year from age 25 to 50, at age 65 they would have saved $312,000, assuming a 5% annual return after expenses.
3) Lower investment costs
Actively managed mutual funds have average expense ratios around 80 basis points (.80%), while most index funds and ETFs are about 20 basis points (.20%). If, for example, our 25 year-old pays only 25 basis points (.25%) instead of 1% in annual investment expenses, her annualized return jumps to 5.75%. This reduces her average savings rate to 13% of her salary, from 15%, if she starts at age 25 and to 22%, from 24%, if she starts at age 35.
One million is still a magic number, at least to most when thinking about their retirement savings. For some it is an easy achievement, but for most people, getting to the magic number will take many decades, many difficult decisions, many mistakes and a lot of perseverance, patience and persistence. It is a difficult dream to accomplish, but it is not impossible with a good plan and consistent follow-through.