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How Far Will A Million Dollars Get You In Retirement?
The term “millionaire” originates from late 18th Century France, and when used thoughts of great wealth spring to mind.
Its literal definition equates to a person with a net-worth of $1 million or more.
However, inflation over the years has since put a dampener on the “millionaire” status; to have the equivalent of one million dollars in 1900, one would require the best part of $30 million to have the same spending power ($28.4 million to be precise).
Incredibly there are currently over 1,800 billionaires in the world according to Forbes magazine.
Within this 1,800 billionaires, are 62 individuals who own equivalent to the poorest 40% of the global population.
The once renowned status is now achieved by some 15 million people in the U.S. alone.
Gone are the days when a million dollars could see a person through life.
It takes careful budgeting and hard work to ensure so much as a happy retirement on $1 million.
However, having a million dollars to retire with, is still a damn sure better than retiring with nothing; an ever increasing amount of retirees are relying on benefits to scrape by on their monthly bills.
With the current average retirement nest egg being $104,000 and the poverty rate for Americans over the age of 65 ever-increasing to a third of all retiree’s in 2013.
Despite the less than impressive reality of a million dollars in 2016, when smartly invested it is perfectly adequate for a comfortable life in an average U.S. city.
It is beneficial to be in a strong financial position when considering retirement, being average is not great regarding retirement savings.
Starting to save early is key to having an adequate retirement fund, especially with people seeking retirement at sooner than expected ages.
There are two first running techniques for correctly investing $1 million throughout one's retirement; these are to purchase an immediate annuity or to invest in a standard portfolio.
Both have several main advantages and flaws that can be systematically weighed out to determine the best option for an individual’s retirement situation.
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Immediate Payment Annuity
This technique, sold by life insurance companies is particularly useful for retirees who have concerns that they will outlive their savings.
By investing their entire savings as a lump sum, they need never worry that they will run out.
This line of investment’s main high point is that the contract is open-ended, should the investor live another hundred years they would still receive the same fixed income for life.
As much as this is a good point, this may also be seen as a possible downside; should the investor die the next day all the money would be lost.
It is effectively the equivalent of taking out an insurance policy against outliving one's savings, an option that should be seriously considered by a healthy retiree expecting to live an extended period.
Two key factors determine the payment amounts; these are interest rates and the life expectancy of the retiree.
Higher interest rates translate to a higher payout from the annuity, similarly longer life expectancy translates to a decrease in the monthly sum.
Interestingly due to the life expectancy of a woman being slightly higher than that of a man in the U.S with men expected on average to live to 76.3, and woman to 81.3, a woman can expect to receive slightly less on average for the same value of the bond.
For example, a 65-year-old woman investing in an immediate annuity in 2015 would have received around $5,400, compared with a man the same age receiving $5,700 when spending $1 million.
There are options of impaired annuity plans for those with lower life expectancies such as smokers and sufferers of particular diseases.
However, these policies have an increased cost.
Another serious issue with investing a lump sum of savings into a monthly payment plan is the lack of financial security in the case of an emergency or the purchase of a major item that may require a large sum of money.
It is possible to buy an immediate payment annuity in another life, such as a spouse, family member or friend.
This allows the guarantee of monthly payments in whole or in part to whom the annuity is purchased.
This is common practice to buy for a spouse allowing regular payments should the annuitant die, ensuring their financial position.
In this position it is also possible to cover the cost of the annuity by taking out a single premium life insurance policy, ensuring a lump sum payment in the unfortunate case that the benefactor should die.
Overall the immediate annuity plan is best for someone intent upon having a fixed income for life as opposed to access in full to one's money.
Investing all of one's savings in an immediate annuity plan is certainly a bold step, which may well pay off in the end.
Traditional Portfolio
This strategy, unlike the immediate payment annuity, involves a measured risk in one's investment.
By investing $1 million in a diverse portfolio, a retiree can ensure that their retirement fund will last over an extended period.
By using modern portfolio theory, and the “4% rule” a pension fund of $1 million could easily last 30 years or more.
Within an investment portfolio, the investor must decide on a risk vs. expected return rate, with the higher risk investments tending to have the higher possible gain.
Assuming the retiree is just investing for the longevity of their retirement fund a lower risk portfolio would be beneficial, spreading profits over an extended period.
The above mentioned “4% rule” is employed to account for inflation, the retiree will withdraw 4% of their investment in the first year ($40,000) and in their second year, they will adjust this withdrawal to account for inflation.
For example, if inflation for the second year were at 2% the second year’s withdrawal would be 4% of the original, plus the 2% for inflation ($40,800).
This is known as a drawdown strategy.
Recently inflation has remained predictable and not excessive, as seen in the graph fluctuating between around 5% and 2.5% per year.
A key strategy when investing in a portfolio is diversification, by investing in a diverse portfolio of assets an investor will have a reduced amount of exposure to individual asset risk.
However despite anyone’s predictions, unfortunately, they will always remain just that, predictions.
It is impossible to predict with any certainty how the market will fare in the future, and what inflation rates will be over the years.
All numbers produced in a portfolio plan are based on expected values, determined by examining the historical return in stock.
This means that any volatility or change to a sector or business can have huge effects on stocks.
A period of high inflation, as seen when in recession, can cause retirees funds to disappear at an alarming rate when invested in this method.
This is shown between 1970 and 1980 in which inflation more than doubled, nearly reaching 15% in 1980.
However if correctly done, and with a little bit of luck, it is possible that one could retire very comfortably with an initial $1 million investment in a portfolio.
Which is better?
When it comes down to it, a future retiree must be asking, “well which of these two options is better for me?”
And overall it comes down to which plan suits the individual, research, and time invested in understanding both techniques can pay dividends in the long term when a person takes the right plan for retirement funds.
Historically with inflation being on average relatively small, the traditional portfolio just about comes out on top of the annuity plans due to its large potential payouts.
However, a bird in the hand is worth two in the bush, and likewise, the security offered when investing in an immediate annuity plan of a steady income for the rest of a retiree’s life should at least give you something to think.
To finalize a person’s individual retirement can be determined on what that individual wants to get out of retirement.
Retiring at 65 with $1 million is expected to translate to around $70,000 per year when taking into account social security income in either retirement plan outlined in this article.
There is not a huge financial difference between traditional portfolios and immediate payment annuity plans.
However, there are very significant differences in the risk involved that should be measured out carefully when deciding upon one's retirement.
Issues such as who will be left behind, and how long you expect yourself to live to weigh out arguments for each plan.
It may be possible to retire with $1 million.
However, it’s always better to play it safe and aim for $2 million.
