The millionaire’s dilemma
What’s the typical income of a U.S. retiree? $40,000? $50,000? Higher, lower?
It’s $31,157 as of 2008.
That’s the median income of households age 65 and older as reported by Pat Purcell of the Congressional Research Service. The median means that half of older households had a higher income, half lower. Technically, it’s not the income of “retirees,” because it includes the income of older households whether they are fully retired or still working. Still, it’s a good metric of the income of retired Americans.
Switching to a slightly different set of statistics, from the Social Security Administration, about 8% of age 65+ households have incomes above $100,000, and about 12% below $10,000.
Most working people I know typically regard $31,000 as a surprisingly low figure for retirement income. Partly that’s because they’re generally well educated and well paid, and are thus hoping for a higher income in retirement. Yet the figure reminds me of a psychological element of retirement income: Even if you are substantially well prepared for retirement, with significant savings, the income you can derive from a given pool of savings may seem modest.
Call it the millionaire’s dilemma. Consider a hypothetical couple who have accumulated $1 million in retirement savings—on top of raising a family, buying a house, and sending some or all of their kids to college. Arguably this couple is one of the best prepared retirement households in the U.S. Assume “he” worked and “she” stayed home. To work with even numbers, assume he’ll be receiving Social Security of $20,000 a year, and she’ll receive a 50% spousal benefit of $10,000 a year. That’s a total of $30,000 of baseline income in retirement from Social Security.
Now, what about the million dollars? If our couple tilts their portfolio toward higher-yielding stocks and bonds, they might be able to generate an income yield of 3%, producing $30,000 a year in dividend income. They could also invest in a balanced strategy and use the 4% withdrawal rule, which helps minimize the risk of running out of money. That would yield $40,000 in the first year of retirement. In either of these two cases, their gross income in retirement is $60,000 to $70,000. This income puts them comfortably in the top quartile of retired U.S. households.
But many millionaires (and the nonmillionaires reading about them) might be surprised at the math. In order to accumulate $1 million, this couple probably was earning a regular six-figure income. They were probably not envisioning retiring on $60,000 to $70,000 a year.
So how does our millionaire couple get to a six-figure income in retirement? One option would be to convert the entire million dollars into a fixed annuity. It might pay $60,000 to $70,000 a year to a surviving couple, depending on their ages, interest rates, and other factors. That, plus $30,000 in Social Security, would put the couple at or near the six-figure level. It would also require the couple to lose permanent control of their assets, something they’d be unwilling to do. At most, they might annuitize a portion of the million dollars to boost guaranteed income. That would keep them shy of their six-figure income lifestyle.
Another alternative is for one of the spouses to have earned a generous public-sector DB pension plan (or generous private-sector pension, though these are growing less common). Let’s suppose the stay-at-home spouse had a better-paying government job with a pension paying $50,000 a year. (By the way, that’s nearly triple the typical public pension of $18,000 a year.) With both of them working, their total Social Security payments would now be, say, $40,000. Add to that the $50,000 pension, plus the $30,000 to $40,000 in income from the million dollars. They’re now in six-figure territory.
What’s the lesson here? It’s not about being a millionaire in retirement. I used $1 million just to keep the math even. You can convert the numbers to your own situation by dividing (or multiplying) by the appropriate factor.
The lesson is that, regardless of the size of your assets, each dollar of retirement savings in a portfolio could generate 3 to 4 cents in retirement income. In other words, you could expect 3% to 4% from a portfolio. You could double that rate to 6% to 7% for assets in an annuity contract, where you’ll need to give up control of your assets.
This is the new retirement math that most Americans, as they approach retirement, are coming to understand. Like the millionaire couple, many will be surprised by the income levels that a pool of assets can generate.
“Asset rich,” in other words, does not necessarily feel like “income rich.”
Note: Annuity product guarantees are subject to the claims-paying ability of the issuing insurance company.
Thank you Steve for drawing attention to the millionaire’s dilemma. Through Vangard’s website I have been tracking how much monthly income (through dividends, capital gains distributions, and interest) I could be receiving if I took my distributions in cash instead of reivesting them as I have been. This gives me insight into what my post-retirement cash flow might be solely from my investments. I was saddend to see that my interest income has gone way down due to the low-interest rate environment we now find ourselves. This means I am counting more on diveneds and capital gains distributions. But looking back on 2009 showed that those two items combined can go negative if there is a heavy weigting towards stocks in the portfolio.
I encourage all Vanguard investors to use the performance section of the Vanguard website to get a feel for what monthly retirement cash flow might be from their existing portfolios. This is truly where the “investment rubber meets the retirement road.”
The good news, as we grow older most of us will spend less. At age 75 most retirees will spend 25% less than they did at age 65 and at age 85 we will probably spend 25% less than we did at age 75.
A real problem of being a saver is we don’t know how to spend. I talked to a banker in Florida this past winter who stated, “more than half of his clientele have more money than they can spend.” This conversation took place in Port Charlotte county Florida which claims to have one of the oldest populations.
When we both retired in 2006, we were counting on the prime money market acct to produce our 4 % aka $40000 per year supplement to our public pensions and starting in 2011 our additional social security benefit. MM yields since that time are under .05% causing us to seek out CDs , short and intermediate investment grade bond funds totalling about million dollars. The composite interest rate for all of these is 3.12% and a bit more complicated than the simplicity of the one money market return. We dropped our expectation to a 3% instead of the 4% distribution as that preserves the million dollar investment. Any additional income over that goes for future inflation.
We can live with this.
Something drastic happens to one’s household accounts when they no longer pay a mortgage, make car payments, contribute to Social Security, save for retirement, commute to work, or finance college educations—the money just piles up.
The problem with many retirees is that they failed to plan early. It is my opinion that if one waits beyond age thirty, or beyond the first birth of any children, than you will probably have financial problems in retirement. The second problem is that far too many people are always in debt. One should pay ones self first and live on the remainder, while placing the payment to yourself in sound long term investments. Most people also believe they are home owners when they have a mortgage, not realizing that there is almost no difference purchasing a house from that of an automobile, other that the length of the loan time wise. When one retires one should not have any debt, if you have debt, do not retire. And lastly, most people think they will be the exception to averages(basic statistics), most people will be average or near average and should plan accordingly. If you are the exception wonderful, but if you are not, understand that I will not knowingly support someone who has demonstrated a lack of any reasonable long term financial discipline.
One problem with your math Steve. The spousal social security benefit will be reduced by 2/3 of the DB amount. It is referred to as the offset for government pensions. The spouse will get no social security.
I think many of us still think of retirement as an entitlement provided to us by… who? Our parents had the good fortune of generous corporate or government pensions following the second world war. We do not. Austerity is the new black. If you cannot provide for yourself, no one will provide for you. You will work until the day you die.
At 89 have put 85% in short term corp. AA Bonds. My advise. During the 60and 70 years do everything you can because as you get near the 90′s there is not much you can do.
The answer to the dilemma is to live on 85% of your income and invest the rest. You will never run out of money.
I think you sell the IRA / 401k millionaires short. I suspect that all of them are just as savy as the people that replied to your blog.
Almost all of my co-workers in their 50s and 60s have more than $1M in their 401k and all of them are very well aware of the realities of MM, bonds and stocks. Like me, they avoid debt and they believe that their cash requirements will go down with age. Afterall, they are seeing close up how their parents lives (many into their 90s) and fortunes have wound down. Rather than outliving their money, most of our parents gave what was left to their heirs so that Medicaid paid for the last 3 years or so of nursing home care.
There are no reasons to believe it will be much different for us over the next 30 to 40 years.
Any advice except “save more”, if SS is no longer available?
I’m 74, and for many reasons don’t need the income I needed when I was working. I never see that mentioned in these talks about retirement income. How about addressing that sometime?
That’s because a million dollars is really worth $100,000 when a million dollars meant something. Now the American dollar is worth a peso.
I am 58 and would like to retire. I have followed most of the advice that has been given over the years. I have no debt, a paid off house, have put 2 kids thru college and have 3 more yrs before my youngest will graduate. My net worth is somewhere near $1.6 million which includes $250,000 equity in the house I live in. I have done this while never making a six figure salary. I have run the numbers and I still do not think I can do it. Most of the shortfall has to do with coping with health insurance costs until I am eligible for Medicare. Also equity returns enjoyed thruout the 80′s & 90′s have been subpar since 2001. The health care costs go a long way to negating all the savings that have been mentioned retirees benefit from when they quit working. Although I have a modest private pension available at 63, that too was cut short by my company when the plan was frozen in 2009.
There’s a fallacy in your argument. Anyone who has managed to accumulate $1MM or more – all the while putting kids through college, paying off a house, etc, etc — most probably lived FAR below their income all their lives. Therefore – even though they may have made six figure incomes (and maybe not) they really lived on the the $50,000 – $60,000 your referenced. Therefore living on that amount in retirement is no big deal at all.
How very true and, at in some ways, very depressing. It does show the importance of starting saving for retirement as early as possible. I’m glad I did, but I still am surprised that, with only a couple of years until retirement, my $3 million portfolio will likely only generate $120,000. I also wonder if the 4% withdrawal rate works if one retires at age 55 rather than age 65?
At 55, you should be looking at the 3% rule, not 4%. Or looking at investments that have built-in inflation hedges, like real return bonds or real estate.
Three points. First, that “Typical retiree income” referenced in the article includes everyone – paupers to millionaires. Perhaps that statistic has little relevance to 6 figure earners. Second, as others have already saId, it’s likely that that those who have put $1M aside are already living below their current income. Third, In looking at retirement planning, a less obvious factor affects the income stream of many retirees, dependence on only 2 sources of retirement income
Few seem to remember the conceptual structure in which Social Security was framed.: that SocSec was intended as 1/3 of a “stool with 3 legs.” The other 2 legs were to be personal savings (then a bank account, now an IRA) and guaranteed pensions, All employees, (especially those who, for whatever reason, had little savings) would profit from the “forced savings” to come from employers having displaced or reallocated some labor costs into pensions. The systematic dismantling of company pensions, paralleling the decline of collective bargaining, destroyed that “third leg.”.
Granted that extravagant demand and inaccurate actuarial calculations had equal power in destroying that “third leg,” it still follows that all employees, including 6 figure workers, experience the absence of that stabilizing third income stream as lost financial security in retirement.
The bottom line is that no matter how conscientious you are as a saver, how well you planned and how long ago you started, if you can’t obtain good rates of return from your capital, you won’t enjoy a high standard of living in retirement. Are you a retired millionaire? Congratulations! But if you are earning 1% in a money-market, your million won’t buy a comfortable lifestyle.
We must be aggressive investors even when we’re wealthy (by net worth). The truly “rich” differ from the merely affluent in their capacity to generate rate of return. I’ve been saving for many years and am comfortable with my savings, but it’s just that – savings – and NOT investment. Now that the 80’s and 90’s bull-market cycle is over, we must realize that a passive approach to “investment” is inadequate. And the alternative – CDs, money markets and the like – is no solution either.
Keep in mind that no income or payroll taxes are due when you are spending money in taxable accounts that are not considered “gains”. If you have saved $1,000,000. and $900,000. has already been taxed it’s free and clear of the governments hands.
The key to a comfortable retirement is expense control. You no longer have a mortgage or car payment or are feeding and educating children. Educating grandchildren is optional. You probably don’t need a lot of life or disability insurance. Your largest expenses will probably be food, home maintenance and health care. So a retiree does not need a six figure income to live well.
OK, I’ve read the foregoing mostly gloom and doom retirement forcasts. I am retired (a little over a year) my wife is a school teacher for 1 more year, she will get a pension but no social security. We put one child thru college, then law school (outrageously expensive) and saved what we could, contributed to a 401k, bought mutual funds recommended by a big financial company, lost some money, made some money (made more when I decided to do my own research on what to purchase). Used wifes salary to pay off house and then didn’t ever buy anything on credit. Point is that I didn’t deprive my family of nice vacations occasionally and fun stuff regularly, Never hit 6 figures on my salary, include wife’s and we did. Now, at 67 wife 64 we will have retirement income of (after tax) SS 2100/mo, Tchrs pension 2050/mo, small pension of 460/mo and we expect to be able to take about 3,500 to 4,000 per month from interest on the 1,500,000 invested with out ever depleting this fund. We have a 150,000 emergency fund in a saving account and plan to leave at least 1mm to our child. Our medical care is covered by medicare part D for me and school retiree for wife. We have not been among the big tiime income people, not extravagant spenders, just ordinary work hard, save what we can, don’t go into debt, have reasonable cost fun life. I know if we can do it so can most people who are not afraid to work hard, stay out of debt and save regularly.