Millennials: You'll Need $4.5 Million to Retire

Today, I read an alarming report that said (among other things) that Americans are guessing at how much money they need to retire... and they are guessing wildly wrong. For example, the median Millennial "guesstimated" that he would need a $500,000 nest egg to retire.

After forty years of inflation, this much latinum will buy you two apples and a hair shirt.

This is great if you have generous children willing to support you, or if you enjoy eating cat food. Otherwise, Millennials, we need to shape up.

To be fair, Millennials are not being uniquely stupid here. Our parents in GenX and the Baby Boom (aka "The Olds") are roughly the same amount of dumb about retirement. But I'm not talking to them, because (1) the Olds are so much closer to retirement they're beyond my help, and (2) they are going to retire into a functional Social Security system, so, while their own irresponsibility might ruin their plans, it won't ruin their lives.

But the first Millennials don't start retiring until 2049. The Social Security Trust Fund will be empty in 2035.  Do the math.

Social Security will still exist after 2035, since the Trust Fund is only one part of its funding, but the Olds' refusal to deal with its massive long-term funding problem now means that it is likely to pay our generation less than we were promised. You can pretty much count on receiving at least half your scheduled benefit. In fact, it's very likely you'll get 75% of your benefit. But beyond that? It depends on the Olds' willingness to raise taxes on the rich, and have you seen their voting records? So let's assume our parents are going to mess this up (as usual) and leave us with the bill (as usual), as they have on everything from student loans to the home mortgage interest deduction. You're going to have a lean Social Security check, so you need to make sure you have enough saved up for yourself.

How much is "enough"?

A very solid rule of thumb is that you need to figure out how much money you're going to spend each year in retirement, then multiply it by 25. This is because a nest egg that large generates enough interest that you can live on it without having to spend down the principal. Your money will replenish itself, and you will (very likely) never run out. Since you have no idea how long you will live -- whether with future medical advances or sheer luck, you could live to age 100 or beyond! -- you need to make sure you're not spending down your principal.

So let's say you're the median Millennial. You were born in 1990, you're now 28 years old, you're living with somebody but probably not married (yet), and your household has a combined total paycheck of around $54,000. You spend the whole paycheck on stuff, from housing to insurance to tax to food to streaming services. You've never even seen avocado toast. Social Security is scheduled to pay you guys about $30,000/year starting at age 67... which means you should probably only count on seeing $20,000/year.

In retirement, your spending habits are going to change: housing costs will go down, medical costs will go up. Middle-aged people planning for retirement in their peak earning years are probably going to be spending less in retirement than today. But you're young, still a ways away from your peak earning years. It's fair to assume that, in retirement, you're going to have expenses that are fairly close to what yours are today.

So you're going to need, more or less, $54,000/year in retirement. Social Security covers $20,000 of that, so your real need is $34,000/year. Multiply that by 25 to get the size of the nest egg you need when you retire in forty years: $850,000. (If you're single, or keep your finances separate from your spouse / consort / platonic lifelong roommate / convent / whatever, halve these numbers.) Under a million bucks stashed away in four decades? That's easy enough, isn't it?

Not so fast. Because there's going to be inflation. Social Security adjusts for inflation automatically... but your retirement savings targets don't. You need to account for it.

If you're real lucky, there won't be much inflation. For people who started working in America in the 1930s, retiring in the 1960s, the average annual rate of inflation over their career was only about 2%. But those people were stupidly lucky with inflation. (Less lucky with having the Great Depression and World War II.)

The long-term average rate of inflation since the Federal Reserve was created -- which is what you should expect -- is about 3.5%.

And if you're unlucky? If you started working in the midst of 1970s stagflation and retired into the Great Recession (as millions of people did), the average annual rate of inflation over your career was as high as 4.3%. That's not what you should expect, but it's what you should prepare for.

Long story short, in forty years, $34,000 isn't going to be worth very much! You'll be telling your grandkids about the Good Ol' Days, when the stuff on the McDonald's Dollar Menu actually cost One Dollar, not $5.25. And you'll need a whole lot more money to buy what you can buy today with $34,000.

Maybe we'll luck out, and inflation will stay low. It's been very low since the Great Recession, which is pretty cool. If average inflation over our careers is only 2%, the "$34,000/year" we need inflates to $75,000/year. Which means you'll need $1.8 million in your nest egg.

But we're probably not going to get that lucky. It's more likely that inflation will be around 3.5%. In that case, you'll need $135,000/year to have the same standard-of-living as you have today, and your actual nest egg? $3.4 million.

But that's just an average. We could easily get unlucky. The millions of people who started working under Jimmy Carter and retired during the Great Recession weren't very lucky with inflation rates at all. You need to prepare for that possibility. If we have average inflation of 4.3% over the rest of our careers, you'll need $180,000/year just to keep pace with that $34,000/year you're looking at today. How much do you need to save up? Just multiply by 25: you're going to need a $4.5 million nest egg to maintain your current standard of living.

And that's after Social Security. And that's assuming your household today earns around the median. If you're making more than that? Then you're going to need even more money in retirement to maintain your standard of living.

Now, there's good news, too. Inflation doesn't just sneak up in the middle of the night and ruin your savings. It will happen slowly, a few dollars at a time for forty years. Your salary is going to get inflated over time, your savings will inflate, your investments will inflate, growing a little extra every year thanks to inflation. When you get there, $4.5 million isn't going to seem as crazy as it does right now.

Nevertheless: you, the median Millennial, should be aiming to have accumulated around $4.5 million in 40 years. That's just to keep living the way you're living now, not blinging it up with round-the-world cruises and gold-plated walkers, and it assumes inflation that is worse than average, but hardly worst-case.

So start saving now! If you and your significant other put 20% of your pre-tax income (that's $11,000 a year, if you're the median Millennial household) into a 401(k) or a Roth IRA, starting now and continuing until you retire, and you keep putting in 20% even as your wages grow in the next few years, and you don't withdraw from your retirement accounts... well, you're gonna make it.

If you already started saving when you were younger, you probably don't even need to put away 20% to keep up. I started saving at 22. Today, even after marrying, raiding my Roth, and stopping some deposits for a year due to a series of financial emergencies, I'm saving only 15% for retirement. I'm no longer ahead of the game, but I'm still on track.

And if you fall a little short? If you're having a rough decade in your 20s and don't start earning real money until your 30s? If you have to raid the Roth IRA to buy a house to fit your growing family? (Full disclosure: I did this.) It's not the end of the world. Start saving when you can. You'll just have to live a little more frugally in retirement than you may have expected. You won't be eating cat food. With even $2 or $3 million by the late 2050s, you're gonna be fine. Heck, you'll need even less than that if inflation stays close to the average.

But you do need to start saving as soon as it's practical. There's no future where $500,000 is going to be enough for a Millennial to retire on. If you still think it is, start stocking up on Fancy Feast.

Editor's Note: This post is definitely a public service and not a sly attempt to get somebody to check my retirement math on the cheap.

UPDATE 6 MAY 2019: A friend of the blog pointed out an error in my inflation calculations. I apparently fat-fingered a formula in my Excel spreadsheet, which caused several figures to come out too low. The ol' Reinhart-Rogoff conundrum! I fixed the error. I then took the opportunity to find a better figure for the median household income of 28-year-olds before recalculating.

The headline figure ("You need $4.5 million") remained the same. However, median household income changed to $54,000 (from $65,000 in the original), a misleading aside on taxes was excised, and the overall annual income need in retirement (in 2019 constant dollars) changed to $34,000 (from $45,000). The annual need in 2059 dollars under the low-inflation scenario therefore changed to $75,000 (from $100,000) and the nest egg to $1.8 million (from $2.4 million). The annual need in 2059 dollars under the average inflation scenario changed to $135,000 (from $133,000) and the nest egg did not change. The high-inflation scenario did not change. Thanks to Jeff P. for pointing out the original error.

Other than that, the story was accurate!

In other news, I've been asked elsewhere to explore these calculations a bit more in depth, for people at various saving and spending levels. While there are many good retirement calculators out there already, I admit I wrote my own, based on the basic plan laid out in this post. I plan to clean it up and post the calculator as a Google Sheet when I get the chance, for those interested.