When is $1 million NOT $1 million?

By now, most every media outlet has run their own take on the GOBankingRates study on how far $1 million will go in retirement in each state.  The study looked at the cost of normal expenditures for the average 65-year old including things like groceries, housing, utilities, etc.  They then factored the expenses by the cost of living index in each state.  Not surprisingly, Hawaii, California, Alaska, New York and my home state of Massachusetts are the most expensive and Mississippi, Arkansas, Oklahoma and Michigan are the least expensive.

Thankfully, some media outlets, including Bloomberg and Huffington Post, thought to question some glaring omissions in the study, but others including CNBC and USA Today merely “parroted” back the results.

The problem with studies like this is that they inevitably rely on averages and ignore the fact that personal situations are the most important factor.  For example, housing costs based on current market levels are mostly irrelevant for a 65-year old who has paid off their mortgage and has no intention of moving, though taxes and upkeep would still be a factor.  Likewise, no reference is made to future inflation or inflation specific to how a person currently or prospectively would spend their money.  Also, no reference is made to expenses for entertainment or travel.  However, the biggest gap in the study is the lack of details related to taxes.

The study seemed to imply that the fictitious 65-year old had $1 million in cash in a checking account to pay their bills.  Of course, if the $1 million was in a retirement account (401-k, IRA, or similar) all withdrawals would be taxed as ordinary income with the requisite income tax liability, depending on the personal tax situation.  Hopefully, this person has other income to pick up the shortfall due to the income tax liability.

It seems that every time we read a story about “your number,” the tax aspect is ignored.  This is certainly due to the difficulty in capturing all the brackets, exemptions and nuances in the U.S. tax code.  However, we at least need to grasp a simple view of the matter so as not to misstate the situation.  In fact, assuming a modest 15% marginal tax bracket (up to $75,900 for married filing jointly) and 5% state tax rate, your $1 million is worth significantly less in spendable cash once it is withdrawn from tax-deferred accounts. 

In round numbers, the $75,900 maximum annual income in the 15% bracket is only worth about $60,720 (75,900*0.8 Federal/State tax) in after-tax income each year from a tax-deferred account.  Withdrawing more would bump you into a higher bracket and provide a progressively lower amount of net income after tax.  In round numbers, $1 million sitting in a tax-deferred account is worth only about $800,000 of net income if you net out the $200,000 that would be due in taxes from annual withdrawals of $75,900 over a 13-year horizon.  For simplicity, I left out the interest-on-interest component; but, assuming a 3% annual return the time horizon would be extended by 4 years.

Tony Ash, 8/29/2017