Since 1840, average life expectancies have increased by around three months for every year that has passed. If this trend continues, infants born in the U.S. at the end of this century can expect to live an average of 100 years.
Living longer is great, except for one tiny problem: Longer lifespans mean longer retirements, and today's workers already struggle to save enough money to finance even a shorter retirement. Will you have enough retirement savings to provide for yourself if you live longer than you expect?
Expected lifespans today
Actuaries live for calculating the average lifespans of people of different ages. Let's look at some of their predictions for how long people of different ages will live on average as of today.
First, a male born Jan. 1, 1997, has a predicted lifespan of 82.3 years today. Second, a male born Jan. 1, 1977, has a predicted lifespan of 82.0 years. And finally, a male born January 1, 1957 has a predicted lifespan of 83.5 years (all these figures were generated by the Social Security lifespan calculator; females of the same ages are predicted to live slightly longer).
You might be wondering why the oldest man in these three examples has the longest predicted lifespan. That's because once you reach a certain age, you're more likely to continue living a while longer. After all, your odds of reaching age 85 look better when you're 65 than they do when you're an infant.
Lifespan and retirement
Longer lifespans generally correspond to longer retirements, especially for those who retire on the early side. For example, if you have a predicted lifespan of 82 years and you retire at age 62, your expected length of retirement is 20 years. But that doesn't mean you can assume a 20-year retirement: Remember, these predictions are estimates of averages. Not only are they not 100% reliable, but your life is likely to be shorter or longer than the average. If the actuaries say you'll have a 20-year retirement, you should budget for at least a 30-year retirement in order to have a decent chance of not outliving your money.
For example, say you decide you can live on $40,000 per year, and you'll be getting $15,000 per year in Social Security benefits. That means you'll need to generate $25,000 a year in income from your retirement savings. If you're budgeting for a 30-year retirement, that would come to $750,000 in retirement savings, right?
Not quite. First, investments can rise and fall in value due to the overall stock market, the economy, and other factors. If the market crashes and your investments lose a significant percentage of their value, getting sufficient income for the year could mean you'll have to sell off an unexpectedly large number of investments. Second, your budget may only account for your most basic needs. What if a major unexpected expense pops up? What if you have a medical crisis that results in some enormous healthcare bills? You'll be forced to tap far more deeply into your savings than you'd expected, putting you at risk of running out of money.
Because you can't predict either your needs or the returns on your investments, you can't simply aim to save 30 times the income you expect to need in retirement. Luckily, there's a better way to figure out how much you should save and avoid exhausting those funds during your lifetime.
Using withdrawal percentages to find your savings goal
Rather than choosing a single hard-and-fast number for how much you can withdraw from your accounts each year, it's better to base your withdrawal amount on how well your investments have performed. If your accounts have produced exceptionally good returns, you can safely take out a little more; in a bad year, you should limit yourself to a smaller withdrawal or (in extreme circumstances) even take nothing at all.
With this approach, you'll keep a goodly balance in your retirement savings accounts that you can draw on in case of emergency. And as you get older, you'll be able to increase the percentage that you take out each year, as you'll be less likely to need such a large amount of money saved up. This approach also means there's an excellent chance that you'll have some balances left over in your accounts that you can leave to your children or the beneficiary of your choice.
From a budgeting perspective, your best bet is to assume that you can take 3.5% of your total account balances during your initial years of retirement. That's how much you can probably take even in a fairly bad year. And if you luck out and happen to get excellent returns during your first few years after retiring, you'll be able to take significantly more. However, by planning for 3.5% withdrawals, you'll ensure that you have enough for your income needs even if you're not so fortunate.
Using this approach, you can figure out how much retirement savings you'll need by dividing your annual income need by 3.5%. So if you've determined that you'll need $25,000 per year from your retirement savings, that means you'll need to have $714,286 in your retirement accounts by the day you retire (that's $25,000/0.035).
Saving that much money might sound like quite the challenge, but fortunately, the returns that your well-chosen investments generate during your working years will likely grow your savings significantly (though if you don't have much time left before retirement, you may have some catching up to do). And the sooner you start saving, the less you'll have to save, because your money will have more time to benefit from compound interest. So the best thing you can do to guarantee a long and well-funded retirement is to sit down today with a retirement calculator, work out a savings goal, and start making contributions immediately. You may need to make some sacrifices today to make that happen, but once you arrive at your planned retirement date, you'll sure be glad that you did.
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