Why Saving $1 Million for Retirement Is Meaningless

Why Saving $1 Million for Retirement Is Meaningless

As inflation continues to rise, saving for retirement is going to get more challenging, especially in the United States.

It becomes even more challenging if savers think that having $1 million saved for retirement is some magic number retirees hit to qualify for the secure retirement club. In fact, we’re going to explore why that kind of saving goal may only provide an illusion of security.

Let’s start by examining how inflation moves the goal posts…

This is not your father’s IRA balance

When Dad saved for his retirement, every dollar he socked away went much further than it does today. Let’s say he was born in 1941.

We’re going to make a couple of assumptions here:

  1. Retirees spend about half the national average wage every year (Social Security and other benefit programs will cover the rest of their expenses)
  2. Retirees need an additional 15% above that number for unexpected expenses
  3. Retirees will enjoy their retirements for about 20 years

When he retired at age 65 his “magic number” for retirement was:

2006
National Average Wage: $38,651.41
Cost to Retire: $444,491

Uncle Dale (Dad’s little brother), born 13 years later in 1954, he reached retirement age just a couple years ago. He saved about as much for retirement as Dad. However, those 13 years made a big difference

2019
National Average Wage: $54,099.99
Cost to Retire: $622,148.85

That boils down to a 40% increase in the cost to retire… in just 13 years.

What’s going on? Why does Uncle Dale need so much more than Dad in order to retire?

It’s mostly because of inflation. (While there are some other complicating factors, too, like near-zero yield on “safe” assets like government bonds, CDs and savings accounts, really, it’s mostly inflation.)

That’s the past, though, right? What happens when we look ahead?

$3 million is the new $1 million

If you’re currently in your 30s the picture appears to get much more dire. It looks like you’ll need $2 million (and that’s assuming inflation stays around 3%, which isn’t likely):

Using an average inflation rate of 3%, the calculation shows you’ll need $2.1 million in savings to equal the purchasing power of $750,000 today.

Personal finance blogger Financial Samurai thinks that, even if you did manage to scrape together $1 million for retirement today, it won’t go as far as you think. You might eke out a meager income throughout retirement (if nothing goes sideways):

If you retired today at 65 with $1 million, you may be able to spend $40,000 a year (4% withdrawal rate) for 25 years. But you might also run out of money before you die as well.

That lifestyle doesn’t make $1 million seem like much. That’s because the buying power you have today won’t be the same 10, 20, or even 30 years from now. So instead of “how many dollars” someone might be saving for retirement…

And that’s what led Financial Samurai to say, “$3 million is the new $1 million.”

But you know what? The numbers don’t even really matter.

Foxtrot - Jason is a millionaire

We have to change the way we think about saving for retirement

Inflation makes the “magic number” of dollars we might think we need for the retirement we want completely irrelevant. Or at least obsolete.

Instead, we can think in terms of purchasing power.

Today’s number of dollars doesn’t matter. All that matters is their future purchasing power.

That’s what makes the Foxtrot cartoon funny. Jason Fox is thrilled to be a millionaire (in Turkish lira) without realizing that his purchasing power hasn’t changed. A million lira buys the same stuff as $13.06…

So don’t spend too much time obsessing over a magic number. Think instead about your purchasing power.

Fortunately, there are some types of assets that lock in purchasing power. Inflation-resistant assets like treasury inflation protected securities (TIPS) and Series I Savings Bonds (I-bonds) grow at the rate of inflation.

TIPS are defined by the U.S. Treasury as an asset that “increases with inflation and decreases with deflation, as measured by the Consumer Price Index [CPI]. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater.” Basically, there’s a nominal yield plus an inflation adjustment you receive when the bond matures. TIPS include a downside guarantee, too, because you always get at least your initial investment back.

You can see current TIPS rates here.

I-bonds are defined as “a low-risk savings product. During their lifetime they earn interest and are protected from inflation” based on the change in CPI. I-bonds are a personal-finance version of TIPS (although individual investors can buy both). In fact, I-bonds were so popular for a time that the Treasury now limits purchases ($10,000 per year in electronic bonds + another $5,000 per year in the form of federal income tax refunds). You can learn more about I-bonds here.

Right now, the yield on I-bonds is 3.54% which looks fantastic compared to CDs or savings accounts… A lot less fantastic when you realize this isn’t actually profit. It’s just a return of the purchasing power devoured by inflation.

Now, both sound like good ideas when taken at face value, because they are protected from inflation. The problem is, both rely on a couple of assumptions:

  1. The reported CPI is accurate. (Looking at “real” inflation, we know the Fed likes to play games with inflation numbers.)
  2. The solvency of the U.S. government. Maybe that sounds silly to you. Students of history might remember the S. debt defaults of 1790, 1861, 1933, 1979, and of course the 2013 near-miss.

The good news is, there are alternatives that don’t rely on solvency or inflation reporting…

Examine retirement assets that preserve buying power

Know why central banks worldwide hold gold? Precious metals have had inherent value for thousands of years because they are tangible and finite resources. Precious metals aren’t controlled by any central bank or any government. Gold cannot simply be “printed” like dollars or euros. Furthermore, gold is an internationally-recognized store of value.

“Store of value” is exactly what we’re looking for. Gold isn’t tied to a magic number that can be doubled or tripled by inflation. This gives physical gold and silver a unique advantage of being a hedge (the word bankers use to describe protection) against inflation. That gives savers a better chance of avoiding the dilemma of planning for tomorrow’s retirement and thinking in today’s dollars. Inflation-resistant assets can help you see beyond the numbers and focus on maintaining your buying power well into the future.

2021, inflation, precious metals, retirement savings