How do most rich people get rich?

[kyphysics]

As others have said, it's barely enough to maintain a middle class lifestyle in retirement.

Location matters, but in an average run-of-the-mill American city (say, Toledo, Ohio, Athens, Georgia, Richmond, Virginia, Orlando, Florida, etc.), would $1M really be that tough to live off of for a mc lifestyle??

assuming you had house and student loans all paid off

And assuming a $40,000/year investment portfolio withdrawal rate.

The 5% includes inflation: it's 8% growth - 3% inflation.

Why is it 8% and not 10% growth?

 

[russ_watters]

Location matters, but in an average run-of-the-mill American city (say, Toledo, Ohio, Athens, Georgia, Richmond, Virginia, Orlando, Florida, etc.), would $1M really be that tough to live off of for a mc lifestyle??

assuming you had house and student loans all paid off

And assuming a $40,000/year investment portfolio withdrawal rate.

Depending on the tax implications and other benefits like social security, that's below the median income in the US, which is $63k. So as I said, barely middle class.

And given that peoples' incomes rise as they advance their careers, for most people that is way below a 65 year old's expected trajectory. The peak median household income is $84k for people between 45 and 54. So if you're at that level and then having to drop to less than half, that's a big drop.

Also, I'm not sure if we said whether this is household or individual income, but I usually talk about household income. And more to the point, I'm not sure what we're after here anymore. This started (months ago) with $1M as a really sub-par definition of "filthy rich", but now we seem to be discussing if it is passable as middle class.

Why is it 8% and not 10% growth?

I didn't pick the number, @Vanadium 50 did, and as he said it's intended to be conservative. I think it's fine. I have the majority of my savings in an S&P index fund and other broad type funds, and the 100 year average is 10% before and 7% after inflation. But people who are in retirement need more stability, so they mix in bonds and have a lower average rate of return.

 

[jtbell]

Location matters, but in an average run-of-the-mill American city (say, Toledo, Ohio, Athens, Georgia, Richmond, Virginia, Orlando, Florida, etc.), would $1M really be that tough to live off of for a mc lifestyle??

assuming you had house and student loans all paid off

And assuming a $40,000/year investment portfolio withdrawal rate.

In my small town in the South, $40K per year would probably work fine in retirement for one person with a paid-off house. Even better for a married couple, if the second spouse also contributes something.

(Note: all figures are in "today's dollars". Adjust them upwards for inflation, including the $1M savings / $40K withdrawal targets, as time goes on.)

The largest single expense for most people is housing. Our house is a modest 2000 sq. ft. 3 bed, 2 baths, 50 years old, on a smallish lot for our neighborhood. It would probably sell for about $150K. (Zillow bounces it between about $140K and $160K.) Utilities are about $5K per year, insurance and taxes about $2K. Mortgage is paid off. So, as a starting point, even though one person doesn't need 3 bedrooms and 2 bathrooms:

$7K housing (not counting occasional major expenses like a new roof)
$2.5K food
$4K car ($20K capital cost spread over 10 years + $1K gas+repairs + $1K tax+insurance)
$4K Medicare + dental, assuming good health
$17.5K total "basic" expenses before taxes

Assuming all the $40K income is withdrawn from an IRA or 401K, it's taxable as ordinary income. I figure maybe $4.5K Federal tax. If state tax is 5%, that's another $2K.

This gives a grand total of $24K expenses for one person. Out of $40K, $16K remains as a cushion for tweaking expenses upwards, e.g. housing in a ritzy place like Toledo, Ohio. ;-)

For a couple, expenses are higher, but probably not doubled overall, because you're sharing the housing costs and maybe the car. If the spouse contributes income, taxable income is higher. The overall tax rate is probably lower (compare tax rates for single versus married filing jointly). Overall the couple comes out ahead, unless the spouse is "dead weight" financially.

Finally, someone who can save up $1M has probably also contributed enough to Social Security to be eligible for at least $25K at age 65, less if you start collecting earlier, more if you delay up to age 70. Reduce it by maybe 25% if you think Congress won't get its act together before the Social Security trust fund runs dry around 2032-2034.

 

[kyphysics]

Depending on the tax implications and other benefits like social security, that's below the median income in the US, which is $63k. So as I said, barely middle class.

I totally get how $63K household income would be struggling middle-class for a working person today.

But, what I was thinking was that the working person would likely have big bills like a mortgage and student loans to pay off that made things so tough. Whereas, a 68 y/o with the same $1M, but a paid off house and paid off loans, could easily get by in an average American city on a middle-class lifestyle (granted, this is subjective) with $40K.

The key for me is no big bills! Just smaller stuff like insurance, food, utilities, and travel. I think with senior discounts on so many things, you could save a lot there too.

Entirely possible I'm also more optimistic, b/c I live a spartan lifestyle. I like minimalism and don't own much "stuff."

So, yeah, there's some subjectivity to what mc means too, I suppose.

And more to the point, I'm not sure what we're after here anymore. This started (months ago) with $1M as a really sub-par definition of "filthy rich", but now we seem to be discussing if it is passable as middle class.

Yeah, sorry about that. Was definitely NOT suggesting $1M would be filthy rich!

Again, subjective here, but I'd personally think you'd need $20M+ to be able to live a luxurious lifestyle.

Agree people should set the bar much higher than $1M. (even if that $1M does not sound that bad at all to me, personally)

I didn't pick the number, @Vanadium 50 did, and as he said it's intended to be conservative. I think it's fine. I have the majority of my savings in an S&P index fund and other broad type funds, and the 100 year average is 10% before and 7% after inflation. But people who are in retirement need more stability, so they mix in bonds and have a lower average rate of return.

Gotcha. Makes sense.

 

[kyphysics]

$17.5K total "basic" expenses before taxes

Assuming all the $40K income is withdrawn from an IRA or 401K, it's taxable as ordinary income. I figure maybe $4.5K Federal tax. If state tax is 5%, that's another $2K.

This gives a grand total of $24K expenses for one person. Out of $40K, $16K remains as a cushion for tweaking expenses upwards, e.g. housing in a ritzy place like Toledo, Ohio. ;-)

For a couple, expenses are higher, but probably not doubled overall, because you're sharing the housing costs and maybe the car. If the spouse contributes income, taxable income is higher. The overall tax rate is probably lower (compare tax rates for single versus married filing jointly). Overall the couple comes out ahead, unless the spouse is "dead weight" financially.

Finally, someone who can save up $1M has probably also contributed enough to Social Security to be eligible for at least $25K at age 65, less if you start collecting earlier, more if you delay up to age 70. Reduce it by maybe 25% if you think Congress won't get its act together before the Social Security trust fund runs dry around 2032-2034.

Very detailed analysis, jtbell. Thanks for the exercise. And, are you serious about Toledo having ritzy housing? I thought it was a working-class steel and manufacturing type of town!

Question on Social Security:

If you become "rich" or even if you just have like the $1M in investment assets we're assuming, does Social Security give you less? In other words, is it like Medicaid, where it is income and needs-based or would it be a guarantee? If a guarantee, is it taxable? I know I can Google these things. Just asking because I'm lazy right now and figured it might benefit the thread discussion (and in case I run across any bad or misunderstood facts).

 

[jtbell]

are you serious about Toledo having ritzy housing?

For some reason, PF's smilies weren't working for me last night, so I had to improvise. Maybe it wasn't recognizable.

I actually grew up in an industrial city in that region, like Toledo, but smaller. I just looked up my old neighborhood on Zillow. The houses on my street (including the one my parents built in the early 1960s) are in the $80K-$100K range. They're slightly smaller than the one I live in now. Our old house still looked pretty good the last time I drove past it a couple of years ago. Actually better than when we lived there, because my parents never got around to doing much landscaping. And there's now a patio or deck in the back, which we never had. I wouldn't mind living there again, if I didn't have to deal with the snow. That's why my parents moved to Florida when they retired!

is [Social Security] like Medicaid, where it is income and needs-based or would it be a guarantee? If a guarantee, is it taxable?

No, it's not needs-based. Your SS benefit is based on how much you (and your employers) contribute to the system via the SS payroll tax (FICA). The calculation is complicated, but you can find descriptions online, including on the official SS web site.

If your only income is from SS, it's almost certainly not taxable. If you have other income above a certain amount, part of your SS becomes taxable, up to a maximum of 85%. (That's not the actual tax rate, it's the percent of your SS that is subject to whatever your tax rate is.) According to this calculator, our hypothetical single person with $40K IRA withdrawals and $25K SS would have 81% of his SS taxable, i.e. close to the maximum. The total Federal tax would be $4450. (Looks like my previous guess without SS was on the high side!)

Many states, like mine, don't tax SS at all, and exempt various amounts of other retirement income (e.g. IRA withdrawals) so you can get a break there.

 

[kyphysics]

No, it's not needs-based. Your SS benefit is based on how much you (and your employers) contribute to the system via the SS payroll tax (FICA). The calculation is complicated, but you can find descriptions online, including on the official SS web site.

If your only income is from SS, it's almost certainly not taxable. If you have other income above a certain amount, part of your SS becomes taxable, up to a maximum of 85%. (That's not the actual tax rate, it's the percent of your SS that is subject to whatever your tax rate is.) According to this calculator, our hypothetical single person with $40K IRA withdrawals and $25K SS would have 81% of his SS taxable, i.e. close to the maximum. The total Federal tax would be $4450. (Looks like my previous guess without SS was on the high side!)

Many states, like mine, don't tax SS at all, and exempt various amounts of other retirement income (e.g. IRA withdrawals) so you can get a break there.

Thanks again, jtbell.

Yeah, that would increase the mc "live-ability," then, of that $1M.

Again, still subjective, but to me, if you're getting $40K from withdrawals and, say, $10K from SS, that seems pretty decent for a place like Memphis, TN, Baltimore, MD, and such "average" American cities.

Also, keep in mind that most Americans nearing retirement age don't have anything near $1M in investments. So, by that standard, maybe OP's $1M is, in fact, "filthy rich" (relative to others). Americans are broke nowadays!