Why You Need $1 Million to Retire

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The occupational hazards of an online columnist are few and far between.

But if there is a danger zone for those of us who write for an Internet audience, it's the comments section of the Web site. It's there that readers have their opportunity to tell us what dopes we really are.

And last week, that's exactly how at least a few readers felt when, writing about the dangers of retiring into a bear market, I used an example of somebody retiring with $500,000 in an IRA.

"McPHERSON NEEDS A REALITY CHECK," wrote (or shouted) GTKERR.

"Who has that kind of money?" added genericjake.

The truth is many do. And many don't.

But the reality is $500,000 is not a lot of money when it comes to retirement. The vast majority of today's American workers need to plan on saving at least that much. And in many cases, they need to shoot even higher. The truth is I would aim for $1 million.

I know to many readers the idea of accumulating a half million dollars or more sounds ridiculous and downright impossible. Let me explain why it's necessary and how it's quite possible. The same answer applies to both questions.

It's called the 401(k) plan.

This creature of the federal tax code has replaced the traditional pension as the dominant retirement plan in the American workplace. The days when an employer will guarantee you a monthly check upon retirement are fading away fast.

You're on your own, and you better wake up to that fact.

If you're retiring within the next few years, there's still a decent chance you will collect a guaranteed pension. But unless you're a government worker, 10 years from now there will be few retirees who can count on one.

That's why you need $500,000 or more.

A married couple, both 65, who are retiring today with $500,000 could buy an immediate fixed annuity that pays them about $37,000 a year for the rest of their lives, according to an annuity calculator on the Vanguard Web site.

Add in $21,000 from Social Security (the average retirement benefit received by married couples in 2008), and you would have an annual income of $58,000. In many parts of the country, a retirement income of $58,000 sounds pretty good.

But we're talking about 2008 dollars. Ten years from now, that $37,000 in annuity income is only going to be worth about $27,500 if you assume 3 percent annual inflation. Twenty years from now, it will only be worth about $20,500. Suddenly, that $500,000 you started with doesn't look so impressive.

I could go on with more examples of how inflation erodes buying power, but you get the point. Shooting for $500,000 or more by retirement is not ridiculous. It's essential. And if you're more than 10 years away from retirement, it's likely to be nowhere near enough. So get going.

For most workers, the best way to do it will be through your 401(k) plan. The combination of tax deferral, an employer match and automated payroll deductions make the 401(k) the best savings vehicle for most workers.

Let's say you're 30 years old, earning $50,000 a year and are 35 years away from retirement with nothing saved so far. Contribute about $246 a month, and at a 7.5-percent average annual rate of return, you would reach the $500,000 goal. That contribution amount is equal to about 6 percent of your salary.

Throw in a 3-percent match from your employer, and you would be on track to reach $750,000 at the same rate of return. Assume annual salary increases, and these numbers will look even better.

The key is to save early and often. If you do, you'll have $500,000 before you know it.

How's that for a reality check?

NET GAINS UPDATE: Last month, I wrote about the warning the Financial Industry Regulatory Authority issued about debit cards linked to a 401(k) account that allow users to borrow from their retirement savings on a moment's notice.

Last week, U.S. Sens. Charles Schumer, D-N.Y., and Herb Kohl, D-Wisc., introduced legislation to ban 401(k) debit cards, which they called a "dangerous practice."

"These debit cards allow participants to use his or her retirement savings to make everyday purchases like buying a cup of coffee," Kohl said in a statement. "Clearly that's not what the 401(k) is for."

This work is the opinion of the columnist, and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com

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