Can I retire on $2 million?

Can I retire on $2 million?

Is it possible to retire on $2 million?

In short: yes. But, of course, it depends on you.

Q: How do I know how much I’ll need in retirement?

A: You don’t.

There are multiple factors involved. At what age will you take Social Security? How much will that give you on a monthly basis? Do you have a pension? If so, how much will your pension payment be? How much do you have invested, and how is that allocated? How much will you spend on a monthly basis in retirement?

The two primary levers that you control are: 1) how much you spend, and 2) how much you’ve saved (and how it’s allocated).

You don’t have any input into whether Social Security changes your monthly benefit. You don’t have any control over whether your pension is being run into the ground. You can’t do anything to influence inflation, interest rates, property tax rates, income tax rates, or the price of tea in Hong Kong.

So you have to make some assumptions. What assumptions should you make? Well, we can turn to history for a guide.

The famous Trinity study (Cooley, Hubbard, and Walz, 1998) found that a 4% withdrawal rate held up across almost all market conditions over timeframes as long as 30 years—so, as the authors report, a 4% withdrawal rate is almost certain to last you through your retirement.

The tables in that article actually show that an asset allocation of 25% stocks/75% bonds actually supported a 6% withdrawal rate for every single period they studied from 1926 through 1995!

But 4% is the number that people grabbed onto, and that’s what became the general rule of thumb.

Another researcher, Michael Kitces, finds that a 5% withdrawal rate is actually quite safe. He’s got the benefit of an additional 20 years of hindsight after the Cooley, Hubbard, and Walz paper. Since the 5% rate holds up well in both studies, we can trust that the 5% withdrawal rate truly is safe.

You could even make a strong case that a 6% withdrawal rate is almost guaranteed to work out, given a typical asset allocation. But I’ll stay prudent and shy away from such extravagant claims ;)

Now, let’s look at the actuarial data on lifespans: if you retire at 65, the odds are that you’ll live about 20 years post-retirement (actually, 20 years for women and only 18 years for men. Sorry, gentlemen).

The nice thing is that you can work backwards from these assumptions. Just remember that they are assumptions. Which means they’re projections. Which is a nice way of saying they’re guesses.

Based on historical data, but guesses nonetheless. Though our results certainly aren’t ironclad, they do provide guidelines to inform our thinking.

So here are our assumptions for this exercise: a 5% withdrawal rate, and a 20-year timeframe for retirement. Feel free to change these figures to suit your own needs and preferences.

The withdrawal rate can be handled using one of two methods.

One: take your annual spending, and divide by .05 (which is 5% expressed as a decimal). Want to use the 4% withdrawal rate? Then use .04 instead. Feeling spendy and want to go with the 6% figure? Use .06.

Two: take 100, divide it by 5. Or divide 100 by 4 for the 4% rate, or divide 100 by 6 for the 6% withdrawal rate. Got the answer? That’s the number of years you expect your money to last. Then multiply your annual spending by that figure.

Methods one and two are mathematically equivalent. I’ll prove it:

Suppose you spend $50,000 per year. Using Method One, you take $50,000 and divide that by .05 for the 5% withdrawal rate. The result is $1,000,000—that’s how much you’ll need in order to retire.

Using Method Two, you divide 100 by 5. That’s 20. So take your annual spending of $50,000, and multiply by 20. The result? $1,000,000.

Like I said: both methods are equivalent. Some people would prefer to multiply, others are okay with dividing by a decimal. Personally, I prefer Method One, and will use that approach here. But either way, you’ll end up with the same answer.

Now, we need to know: how much do you spend in a year? You’ll need to withdraw enough money to cover your spending, plus taxes. Think of your 401(k) or traditional IRA distributions like a paycheck, because they will be subject to the same taxes as a paycheck would be.

Some 401(k) providers will withhold taxes for you, just like your employer did when you were still working. But you’ll want to check on this, because it will affect how much you’ll withdraw.

Remember, your contributions to the plan were made tax-free over the years, so Uncle Sam is going to want his cut eventually! Once you retire and start taking the money to live on, you’ll be subject to income tax at the normal rates.

In terms of taxes, it’s obviously in your best interest to minimize your spending so that you can remain in the lowest possible tax bracket for your desired spending.

For example, we’ll assume you’re married. If you and your spouse want to spend between $75,000 and $85,000 per year, you’d be well-advised to keep your withdrawals below $80,250, so that you can remain in the 12% bracket.

If the two of you spend $80,251, that extra $1 will be taxed at the higher 22% rate. Every dollar between $80,250 and $171,050 will be taxed at the higher 22% rate. Once you hit that point, every dollar over $171,050 will be taxed at the 24% rate, up to $326,600. And so on—you can see the table for yourself at this page. I’ve been using the 2020 figures; the numbers change a bit every year.

So if your spending + taxes amount to less than $100,000 per year, that 5% withdrawal rate means that a portfolio of $2 million will probably suffice.

I can hear some people now: “But wait a minute! What if I live longer than average?”

That’s okay, our oversimplified calculations have a built-in safety margin.

You see, if you hold stocks and/or bonds, your portfolio probably generates dividend income. Historically, bond funds generate dividends of approximately 2%.

That means that a $2 million portfolio that consists entirely of bonds will generate about $40,000 in dividends per year. So if you can live on $40k, you won’t even need to touch the $2 million! In that case, your portfolio can support you forever!

There will be some dips and some increases in the value of the portfolio, but that’s only to be expected with investments. Yes, even with bond funds, though the ups and downs alike will be relatively modest compared to stocks.

Most financial advisors will advise you to have at least a portion of your portfolio in stocks. Even if you want to be very conservative in your retirement and only put about 20% of your portfolio into stocks, that’s $400,000. If the remaining $1.6 million are in bonds that yield about 2%, that’s $32,000. That means you need to withdraw only $8,000 per year to reach that $40,000 figure.

At that rate, that $2 million will actually last for decades!

And we haven’t even counted any money from Social Security or pensions yet! Your SS payments will vary based on how much you made during your working career and how long you worked.

It’s hard to estimate how much SS will pay you without having access to your specific information. The Social Security Administration mails out letters summarizing the information they have for you, so you can use that to help your planning.

But even if we assume that you made a fairly modest salary during your working days, it’s likely that you’ll receive at least $15,000 per year, and quite possibly more.

How much income do we have so far? Well, count $32k from dividends, $8k from 401(k) distributions, and $15k from Social Security. That’s a total of $55,000. Subtract taxes and you’ll wind up with about $43,000 to spend.

Note that people who work in the field of retirement planning find that, as a general rule, people tend to spend less as they age. So if you’re used to living on anywhere close to a $55,000 salary while working, your $2 million nest egg should easily support you, as well as leaving some flexibility for other expenses like traveling, helping to pay tuition for the grandkids, etc.

“Wait!” you say, “I worked hard during my career, and I plan to live it up during my retirement!”

No problem. Basically, if you plan to spend less than $100,000 per year, I’d say that $2 million should allow you to retire comfortably with little worry. In fact, I’ve already calculated that $1,250,000 should be enough to support a more modest retirement lifestyle.

Why take more than 1400 words to tell you this? Well, it’s important to share my reasoning and my assumptions.

But instead of giving you a proverbial fish only to leave you hungry, I’d rather teach you how to fish! You may want to re-read this guide later, or play around with some different numbers.

So with that in mind, here’s a table to help you:

Annual spending	Portfolio needed to support 3% withdrawal rate	Portfolio needed (4% WR)	Portfolio needed (5% WR)	Portfolio needed (6% WR)	Portfolio needed (7% WR)
$30,000	30,000/.03 = $1,000,000	$750,000	$600,000	$500,000	$428,571.43
$40,000	40,000/.03 = $1,333,333.33	$1,000,000	$800,000	$666,666.67	$571,428.57
$50,000	50,000/.03 = $1,666,666.67	$1,250,000	$1,000,000	$833,333.33	$714,281.71
$60,000	60,000/.03 = $2,000,000	$1,500,000	$1,200,000	$1,000,000	$857,142.86
$70,000	70,000/.03 = $2,333,333.33	$1,750,000	$1,400,000	$1,166,666.67	$1,000,000
$80,000	80000/.03 = $2,666,666.67	$2,000,000	$1,600,000	$1,333,333.33	$1,142,857.14
$90,000	90,000/.03 = $3,000,000	$2,250,000	$1,800,000	$1,500,000	$1,285,714.29

Remember, this does not count Social Security, pensions, or even dividend income. So the “annual spending” is really how much you’ll need after considering those other sources of income.

You can see that $2 million covers just about all the cases shown here. I’ve used red font to denote the situations where $2 million just won’t cut the mustard.

Even then, once you account for dividend income and growth of the principal, your money might actually last longer than you’ve calculated!

Now you can use your newfound knowledge to plan more confidently, based on your own specific situation. Happy retirement!

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