Pity the poor millionaire retiree

“Who wants to be a millionaire?” Just about everybody active in private investing. Certainly, for many Australians the idea of retiring with a lump sum of $1 million in investable assets (that's assets outside of the family home) is increasingly a common target.

But here's the plain truth: a couple retiring with $1 million in investment assets can't expect much more than a modest retirement. Indeed, it is a trap that those on the wealth accumulation side of retirement need to be absolutely aware of. We can't afford to romanticise the $1 million figure – it may not be enough to give us the retirement that we hope for.

Boston Consulting Group produces an annual report on household financial wealth (excluding the value of the residence), and in the report released in 2014 found that there were 195,000 Australian households with $1 million in financial assets. Perhaps the most interesting element of the report was the way the number of millionaires in Australian had changed in the previous two years – up 70,000 households. Millionaire status is not as elite as it once was, and it is growing fast. Indeed, the phrase “millionaire middle class” was linked to the study results.

Calculating the rate of withdrawal

It is worth thinking about what retirement might look like for someone with $1 million in investment assets – to see what retiring as a “millionaire” really provides. To do this, we need to think about the rate at which we can “withdraw” money from an investment portfolio.

Cooley, Hubbard and Walz, in their research published in the Journal of Financial Planning and entitled Portfolio Success Rates: Where to Draw the Line, look at 85 years of historical data to conclude that provided a person has 50% of their portfolio exposed to large company shares, they could look to make inflation-adjusted withdrawals starting at a withdrawal rate between 4% and 5%. Spitzer, Strieter and Singh from the State University of New York considered withdrawal rates during retirement, and found that drawing at a rate of 4.5% a year left a portfolio with a 60% exposure to growth assets with a 12% chance of running out of funds if they increased their initial 4.5% withdrawal by the rate of inflation over time. The 12% chance of running out of money sounds somewhat dramatic – but keep in mind that the withdrawals can be reduced if needed.

These figures (4% to 5% a year and 4.5% a year) are not inconsistent with the rate of withdrawal that would come from just spending the income from an Australian portfolio that is around 50% cash and 50% shares – with the expectation that the share income would grow over time. The net result of this analysis is that a portfolio withdrawal rate of 4.5%, with withdrawals increasing with inflation, would seem to be a reasonable drawing rate for retirement.

Back to our couple with $1 million at retirement – a 4.5% withdrawal rate would see them withdraw $45,000 from their portfolio in the first year, and then increase their withdrawals by the rate of inflation each year.

Looking at lifestyle

So what sort of retirement does $45,000 a year buy you? According to ASFS, who produce a quarterly estimate of retirement living costs, a “modest” lifestyle for a couple costs $33,664 a year, with a “comfortable” lifestyle costing $58,126. So a couple retiring with $1 million ends up with a lifestyle between “modest” and “comfortable” – which might not be the romanticised idea of a “millionaire” lifestyle from days when everything was cheaper!

Indeed, the conclusion that the millionaire lifestyle might be more modest than the images we have is supported by the current assets test for the age pension. A home-owning couple with $1,145,500 of assets is the upper threshold for receiving a part age pension. Let's assume the millionaire couple had $45,500 of lifestyle assets along with their $1 million of financial assets, and is not restricted by the income test. Retirees receive $1.50 of age pension per fortnight for every $1,000 they are under the asset test limit. In this case the couple is $100,000 under the asset test limit and so will receive $150 per fortnight in income. This pushes their $45,000 withdrawal from their portfolio to an annual income of around $49,000.

A millionaire-style retirement

The question might be – what level of portfolio wealth gives us a “millionaire” retirement? Obviously this is something that needs to be worked out individually. However, my thoughts are that adding an overseas trip ($10,000) every second year, a nice domestic holiday ($2,000) each year, a nicer car ($2,000 a year) and an extra $5,000 a year (about $100 a week) for entertainment to the “comfortable” lifestyle ($58,128 a year) and we have what we might categorise as an “extensive” lifestyle. The cost? $72,000 a year for a couple. 

If we then reverse calculate what size portfolio would be needed to withdraw at a rate of 4.5% a year (increasing with inflation), we find that $1.6 million is the magic number.

Conclusion

The harsh reality of inflation is that the somewhat mythical “millionaire” status doesn't guarantee an expansive lifestyle. Indeed, a $1 million investment portfolio at retirement doesn't even give us what ASFA suggest is required for a “comfortable” lifestyle. A $1.6 million portfolio might provide a retirement lifestyle more in keeping with millionaire expectations – providing $72,000 a year with a little extra for an upgraded car, overseas travel and extra funds for entertainment. 

Scott Francis is a personal finance commentator, and previously worked as an independent financial adviser. The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.