What is Required to Save $1 million?

Admit it.  When you read “one million dollars”, your pinky finger goes up to the corner of your mouth.  Dr. Evil may have missed the mark by blackmailing the world for the paltry sum of $1 million in 1990 but this sum still represents a psychological threshold for many individuals who are planning for retirement.  But how do we save $1 million?  Does this sum even make sense for us? 

Whether or not saving $1 million for retirement makes sense for your plan, we can still use this figure to model the math and describe what it takes to achieve a savings goal. Numerous sources of information aimed at retirement planning exist. Online resources, including The Motley Fool and Nerdwallet, are just two examples.

Persistence

Setting aside the possibility of one day of receiving substantial inheritance or winning the lottery, saving for retirement takes disciple and time.  In a previous post, I discuss the benefits of putting a plan in place as a starting point toward achieving life objectives.  Retiring by age 65 might be one of those goals.  To save enough money for retirement, it is best to take a persistent approach.  When it comes to saving, the most important idea is to treat the act of saving as a necessary use of money.  Just as paying our mortgage or rent, buying food, and paying taxes are all necessary; so should we consider saving. 

In my experience, consistently saving and investing money is the most important factor in building wealth and saving for the future.  When saving is treated as a discretionary use of money, it is much more likely that it will be a lower priority. Unfortunately, too many of us don’t (or can’t) treat saving for retirement as a necessary use of our money. According to the Federal Reserve Board, 25% of non-retired Americans did not have any retirement savings as of 2021.  For some people, it can be very difficult to set money aside for retirement when other mandatory expenses fully consume their income. For others, persistent saving may come down to deciding between competing priorities. 

Having a plan in place is critical to align behaviors and decisions with life goals.  For example, it may not be feasible to both move to a new high cost of living area and retire before age 65.  Our plan reveals what type of savings and investment returns are required to fulfill our goals.  When we explicitly build saving and investing into our monthly budget, we stand a better chance of meeting our goals.       

Time and the Power of Compounding

To save $1 million, we need persistence. However, we also need time. The more time we have to save and invest in pursuit of a goal, the less money we will need to save in any one time period.  Compounding is the process in which an asset’s earnings are reinvested to generate additional earnings over time.  This growth happens because the asset generates earnings from both the new investment amount each period as well as the accumulated earnings from prior period investments.  Therefor compounding relies on both persistence and time to work its mathematical magic.

Assuming our goal is to retire at age 65 with $1 million in savings/investments, we can model what it takes to get there.  To simplify the model, we ignore the impact of inflation (more on this force later). Assume compounding happens annually, and pretend we earn a flat 6% return each year.  Furthermore, this model assumes we start saving for retirement at age 25.  Under these conditions, we would need to save $505 each month for 41 years (~$250k in total out of pocket savings) to achieve our goal. 

What happens if we don’t start saving for retirement until we’re 40?  Keeping the other assumptions the same, we would need to save $1410 every month in order to reach $1 million by age 65.  The total contribution required increases by nearly $200k because there is less time for investments to compound.

You can test different scenarios and assumptions using this investor.gov compound interest calculator. The key message remains the same – persistence and time are what is required to save $1 million (or any other amount).

Impact of Inflation

It is hard these days to avoid news of how inflation is eroding our purchasing power.  The impact that inflation has on the value of our money is as inevitable as compounding.  Unfortunately, it moves in the opposite direction.  Had Dr. Evil obtained $1 million back in 1990 and stashed it away in his lair, it would really only be worth $452k in 2022 dollars.  That’s because we’ve experienced an average inflation rate of 2.5% per year over the last 32 years; resulting in a cumulative price increase of 121%!  If you want to make yourself sad by modeling inflation rates across different time periods, try this CPI Inflation calculator.  

To save $1 million for retirement might be a worthwhile goal. However, we need to put our goal into context with our overall plan and external factors such as inflation.  It makes sense to engage with a financial professional and/or utilize a retirement calculator such as the one at Fidelity’s site.  Retirement planning tools that leverage Monte Carlo simulation can be helpful in planning for retirement, though they are not without limitations.  It is a good idea to educate yourself on the pros and cons of the specific retirement modeling tool(s) and/or professional financial advisors you select.

Retirement Saving Accounts

Today we have access to numerous savings and investment instruments – too numerous to describe here. Fewer options exist for accounts specifically intended to save for retirement.  Most of us do not have access to company sponsored pensions so it is imperative that we understand and utilize these accounts in accordance with our overall plan, employment situation, and tax status. Whether our goal is to save $1 million or some other amount, these retirement saving accounts are important options to learn about and leverage within our overall plan.

401(k)

This is the most common type of workplace retirement plan.  Your employer might match a portion of your contribution – if so, this is free money!  These plans are normally easy to set up and automatically contribute to every month.  Automatic contributions greatly aid in the persistence required to save for retirement. When we remove money up front, we essentially pay retirement as an essential expense before we can spend it elsewhere. As of 2022, the annual contribution limit is $20,500 unless you’re 50 or older and then the limit increases to $27,000.  These are higher contribution limits as compared to IRA’s.  Employee contributions to non-Roth plans reduce taxable income for the year.  Contributions made into Roth 401(k) plans don’t offer an immediate tax-break. However, withdrawals from the account are not taxed in retirement.

401(k) plan investment choices are limited to certain funds selected by the employers fund management company. This means there are fewer options than in an IRA. In a traditional IRA you can choose to invest anywhere in the market. This is similar to if you were a retail investor investing money outside of any retirement plan.  New employees may have a waiting period before they can contribute to a 401(k) plan.  Also, it is very likely they will be subject to a vesting schedule in which employer contributions becomes the employee’s property only after working at the company for some amount of time.  Despite these conditions, 401(k) plans are an excellent way to save for retirement.

IRAs

Individual Retirement Accounts are one of the most common retirement plans.  An individual can set up an IRA at a bank or brokerage firm.  The IRS dictates how much an individual can contribute to an IRA annually.  Different rules exist for how IRAs are taxed or not depending on the type of IRA we select. Individuals have more control over the money that goes into an IRA. This includes which financial institute will hold the account, which investment choices to use, and how and when to accept the tax break.  Investments made in traditional IRA’s lower the tax burden in the year contributions are made.  In contrast, distributions from Roth IRA’s in retirement are not taxed, but contributions do not lower current year taxes.

The annual contribution limits for IRA’s are lower as compared to traditional 401(k) plans.  As of 2022, the maximum amount you can put in an IRA is $6000 ($7000 if you’re 50 or older).  In addition, Roth IRA contribution limits begin to decrease once your adjusted gross income hits $129,000 (or $204,000 for joint tax filers).  Despite these restrictions, IRA’s represent an excellent way to regularly save for retirement.

Start now to save $1 million?

Persistence, time, compounding, and education are the keys to save $1 million for retirement. Saving money is not complicated but it can still be challenging. Hopefully it is clear that starting today is better than starting tomorrow. Simply start and continue. If you are no longer 25, it’s almost never too late to start. But be aware that as you get further down life’s path, time will limit the benefit of compounding. Do some research, make a plan, max out your 401K, work for an employer who does matching, get an IRA or two, and aim today for a goal down the road. Take action now and persist until you are ready to retire – why wait?

Written by: A. Reed Reviewed by: B. Holman