Americans are living longer than ever. Today, the average life expectancy is 78.6 years, according to the U.S. Centers for Disease Control and Prevention. For women living in the U.S., it's just over 81 years, while it's a squeak over 76 for men. That's leaps and bounds from 1950 when the average life expectancy was merely 68.2. Back then, women lived to be 71 on average, and the average life expectancy for men was 65 1/2.
In 1950, Americans retiring at 65 were expected to spend between three and six years in retirement, on average. Now, someone retiring at 65 can expect to live 13 to 16 more years on average. And there's no telling if you'll outlive the average American. The number of people aged 100 and older is expected to keep rising, reaching 400,000 Americans by 2025.
The prospect of spending a longer period of leisure after a long life of working sounds delightful. But more than life expectancy separates modern adults from Americans in the 1950s. The need to plan for a robust financial life in retirement is much greater today than it was back then. Pensions are few and far between. Sky-rocketing healthcare costs consume a far greater share of retirees' income than ever before.
So how do you plan for retirement? You need to achieve three financial goals on your way there.
1. An emergency fund
Sadly, an emergency savings fund is something a lot of people don't have. Among Americans, 40% wouldn't have an extra $400 if they suddenly needed it for an emergency, according to the U.S. Federal Reserve. But it's the top priority in preparing for retirement, because not having adequate savings can jeopardize the rest of your financial life.
If you believe your life is calm enough today to avoid a single financial emergency forever, think again. Your car could suddenly require a repair, and if you can't afford it you'll be hard pressed to get to work. Perhaps you visit the emergency room, or you encounter other unexpected out-of-pocket medical expenses. What if you lose your job? Even if you receive unemployment benefits, they can take time to kick in and you'll need to cover your costs in the meantime.
An emergency savings fund will cover the immediate expenses that can't be put off, in dire times when your checking account won't cover them. Financial planners advise folks to keep an emergency fund stocked with the savings equivalent of three to six months of your salary.
One minor emergency can precipitate a series of disasters when you aren't on solid financial ground. You need to be able to fix your car if it breaks, to avoid being unable to arrange transportation to work and then earning less or even getting fired. If you incur healthcare expenses, you need to be able to pay out-of-pocket expenses before the bills go into collections. If you lose your job, you'll need to survive of course, but also take care of your family while you look for work.
There are a million financial emergencies that could occur, and you need to be ready to face them financially, so you don't get derailed in retirement. And that means having a robust emergency fund in place before you get close to retiring.
Once you do tap your savings fund for an emergency, be sure to replenish it once you get back on your feet, restoring your emergency savings to the initial amount. This way, it will always be well-stocked for the next inconvenient cost around the corner.
2. A retirement nest egg
The second goal is a healthy retirement savings account balance, or nest egg. Social Security was designed to pay about 40% of the annual income people had before retiring. But to live comfortably, retirees need roughly 80% of their preretirement income, which creates a shortfall that must be remedied.
How much is enough for retirement? One rule of thumb is to save 10 times the money you'll need each year in retirement. Do you want an annual income of $50,000 in your golden years? Then your target for saving is $500,000.
Don't be intimidated if this sounds like a lot of money to save, because you don't have to save every dollar yourself, thanks to investing and the power of compounding growth.
If you're 35 and your salary is $50,000, saving 8% of your income annually for the next 32 years would enable you to retire at 67 with $503,802 in your nest egg. (This example assumes an 8% average annual return in your retirement savings and a 2% average annual salary increase.)
There are two primary retirement savings vehicles where you should consider directing your retirement savings.
The first is a defined-contribution plan offered through your employer, with the most common being a 401(k). In a 401(k) plan, you contribute a certain percentage of your salary to direct into this investment account, and it's taken out of each paycheck pre-tax.
Many employers offer a match in their 401(k) plans, usually between 50% and 100% of what the worker contributes of their own paycheck. For every amount you contribute, they contribute a matching amount, and it doesn't cost you a cent. In 2019, you can contribute up to $19,000 to a 401(k) every year (The maximum is raised to $25,000 for people who are 50 years old or older.)
A 401(k) plan is tax advantaged. The money is taken out of your paycheck pre-tax, so you don't pay any tax on it until you withdraw it in retirement, when it's taxed at your ordinary income rate. This helps you defer the tax you owe, and it has the potential to put you in a lower tax bracket in the year you contribute the funds. Plus, your returns and capital gains grow tax free until they are withdrawn.
The second is an individual retirement account (IRA). IRAs are self-directed, meaning you pick your own investments within the fund, and they are not offered through an employer.
They come in two flavors: a traditional and a Roth. Both types are tax advantaged, but in different ways.
In a traditional IRA, your contributions are tax deductible in the year of contribution (up to April 15 of the following calendar year). The money grows tax free, but it will be taxed as you withdraw it in retirement -- traditional IRA funds are counted as taxable income for the year you take them out.
In a Roth IRA, the tax treatment is reversed. Roth IRA contributions are not tax deductible in their year of contribution. Like traditional IRAs, they grow tax free, but you receive the tax advantage when it comes time to withdraw the funds. Qualified withdrawals from a Roth IRA are not taxed at all. For 2019, you can contribute up to $6,000 per year to an IRA (or up to $7,000 if you're 50 or older).
3. A low debt balance
Americans carry a lot of debt. U.S. consumers owed a total of more than $13.5 trillion at the end of 2018, according to the Federal Reserve Bank of New York, an all-time peak. Individuals owe more than $52,400 in debt on average, according to a GoBankingRates survey.
Some debt provides advantages, like mortgage debt which of course gets you a house, but an added benefit is that the interest you pay can be deducted from your taxable income, saving you money in taxes.
Other debt can negatively affect your monthly budget. Debt service takes a big chunk out of your disposable income, which can hamper your ability to save for long-term goals like retirement -- or it could mean you can't set aside money in savings at all.
Without a savings account for safety, an emergency might dig you further into debt. Carrying a heavy debt burden can severely hurt your credit score, which, can in turn raise your interest rates on credit cards and mortgages.
Constantly having to use your hard-earned money to cover interest payments might mean your retirement savings suffer or are even nonexistent. Unfortunately, 42% of Americans have zero savings for retirement, according to the Center for Financial Services Innovation.
Make every attempt to keep your debt at a minimal level, or ideally at zero, as you approach retirement.
How do you get to retirement?
Reaching these three financial goals takes planning. Don't take these steps sequentially, but rather start approaching all three at once. The earlier you start saving for retirement, the more you'll have, because growth compounds exponentially over time. You never want to be caught without an emergency fund, and any debt you're carrying hampers your credit score and your savings.
First, draw up a budget, by itemizing your expenses and then comparing them to your income. A budget will allow you to see how you can save and how much. It lets you see how quickly you can pay down debt. If you have disposable income, figure out how much to allot to each of your three newfound priorities.
If you can't identify disposable income in your budget, there are several steps to take.
First, look for a higher-paying job or take the steps to request a raise. Second, cut your expenses and reduce your costs. Third, consider taking a part-time job or joining the gig economy for a side hustle that brings in extra income.
Achieving these goals will make you more financially comfortable in retirement, which is a goal worth striving for.