According to a Pew survey, only 51% of Pennsylvanians have tried to figure out how much they need to save for retirement—and just 31% are satisfied with their current financial condition.1 Pennsylvania generally follows national trends, and I would guess that a national survey would have similar results.
We could speculate on the reasons for these results, but a recent Financial Industry Regulatory Authority (FINRA) survey holds some of the answers.2 “In Pennsylvania, 47% of individuals lack a rainy-day fund.” These are people who never disciplined themselves to live below their means and save enough to retire comfortably. The first key to financial success is to live below your means—this is the only reliable way to accumulate savings. Once enough savings are accumulated for a rainy-day fund, excess savings should be invested for growth that could eventually lead to financial freedom.
The FINRA survey also revealed that 38% of Pennsylvanians with credit cards paid only the minimum on their credit cards during some months in the last year. This is not surprising, considering the lack of rainy-day funds. Many people who don’t have emergency savings turn to credit cards to cover unexpected expenses.
This goes against another key to financial success: eliminating the use of debt. Debt-free living requires strict discipline to control spending. Once in debt, a family needs to cut spending even more aggressively to achieve financial freedom: they must build savings and pay off debt at the same time.
The average retirement savings of Pennsylvanians was $411,490, placing them 13th out of 51 states (District of Columbia included separately).3 Can Pennsylvanians retire on this amount of savings? The median household income in Pennsylvania was $61,744 in 2019.4 Using the 4% prudent withdrawal rule, a retiree would need savings of $1.54 million to replace $61,744 of income. This amount could be reduced if the retiree is eligible for Social Security and/or pension income and they are content to rely on those incomes.
To accumulate $1.54 million for retirement, it would be best to start early. Saving 10% per year and assuming a 7% return, it would take 42 years to grow a nest egg to $1.54 million. If 42 years sounds like a long time to save for retirement, there are a couple of options to consider:
- Save more than 10% — Saving 15% of income would reduce the time it takes to reach $1.54 million to 36 years. Studies have shown that millionaires regularly save 25% of their income.5 At 25%, the timeline shrinks to just 29 years.
- Spend less in retirement — Changing the retirement goal to 80% of current income ($49,400) reduces the nest egg required to $1.23 million. Saving 10% of income would take 39 years to grow to $1.23 million—and 33 years saving 15% of income.
Time is your best ally for financial success, so start early. Here are a few other tips to close the retirement funding gap:
- Take advantage of a savings match — Many employers will match a percentage of their employees’ contributions to the company 401(k) plan. You should contribute at least as much as the employer will match. On top of the employer match, you may be eligible for tax benefits to boot.
- Save the windfalls — Tax refunds, COVID stimulus checks, a bonus from your employer, inheritance, etc., could all go into long-term savings. Pay increases could also be used to increase retirement savings automatically. You may not notice it now in your paycheck, but you’ll see it year after year as your retirement account accelerates.
- Do not spend your savings — Don’t use the money you have accumulated for financial independence for any other reason. To do so will cause a significant setback to achieving your goal. Money spent can no longer grow and compound to provide an income in the future.
- Use a Health Savings Accounts (HSA) — An HSA is defined as a type of savings account you can fund on a pre-tax basis. Withdrawals used to pay for qualified medical expenses are also tax-free. After age 65, an HSA can be used to pay for any expense and act as another traditional IRA without the required minimum distributions. A qualified health plan is required to open an HSA, so not everyone is eligible.
Saving more and investing better could help Pennsylvanians close the retirement gap. Most people know they need to start saving sooner so that compounding can work for them over a long time. The challenge is to get retirement savings high enough on the priority list.
- The first key to financial success is to discipline yourself to live below your means to accumulate savings.
- The 4% prudent withdrawal rule is based on a study that shows how a diversified investment portfolio, using a moderate allocation between stocks and bonds, may be able to support distributions of 4% per year without running out of money.
- Increasing savings and reducing retirement spending goals are two ways to shorten the time needed to save for retirement.
- Pennsylvania Taxpayers Face Burdens of Insufficient Private Sector Retirement Savings. By John Scott & Andrew Blevins, The Pew Charitable Trusts, October 28, 2020.
- National Financial Capability Study. FINRA Investor Education Foundation.
- What Is the Average Retirement Savings by State? By Personal Capital, July 30, 2020
- 2019 Median Household Income in the United States. United States Census Bureau, September 17, 2020.
- The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. By Thomas J. Stanley. Taylor Trade Publishing; Reissue edition (November 16, 2010)