Saving for Retirement
While many Americans know they should be putting money aside for retirement, few are confident about how much they’re saving and whether it will be enough for the retirement they imagine. These are all legitimate concerns – and it’s awesome that you’re thinking about them now. We can make good choices today so that when we’re sitting on a porch in retirement we’ll be complaining about “kids these days,” and not our retirement savings.
So, the big question on your mind is probably, “what should I be doing to save for retirement?” The short answer is: find out how much money you can afford to save, open a retirement savings account, make sure you meet any employer match, and make savings a priority. Easy as pie, right?
Sort of….the best answer as to how much you should save for retirement depends on your situation (don’t you love to hear that?). So let’s dig into that question. In this guide, we’ll help you:
- Navigate the conventional wisdom about retirement saving
- Provide some good benchmarks for measuring your progress towards a comfortable retirement
- Provide practical tips to help you boost your retirement savings and be financially prepared for the future
Let’s get started!
Retirement Savings Rule of Thumb
Wouldn’t it be nice to have an easy way to measure your progress? Here are a few popular retirement rules of thumb and how to apply them to your situation.
Replace 80% of pre-retirement paycheck
How much income will you need in retirement? Many financial planners suggest aiming to replace 80% of your pre-retirement income. For example, if your pre-retirement salary is $70,000 per year, you’ll need to make $56,000 annually from some combination of Social Security, pensions, withdrawals from retirement savings (401K or IRA) and other sources of income.
The theory is that you’ll need less money to maintain your current standard of living in retirement because you’ll no longer be contributing to retirement accounts, you’ll ideally have your mortgage paid off and likely won’t be financially supporting your children.
Save 15% of your income
Other financial planners recommend that you save 15% of your pre-tax income each year, from ages 25 to retirement. This may seem like a lot, but if you have a 401(k) with an employer match or profit sharing, the amount your employer kicks in counts toward your annual savings rate. For example, if your employer contributes 3% of your annual salary to your retirement account each year, you would only need to save 12% of your salary to reach a 15% savings rate.
If you’re freaking out right now because you aren’t contributing anywhere near 15%, don’t stop reading! First of all, something is WAY better than nothing. So whatever you are contributing, keep it up, buttercup. Later in this guide we’ll tell you about simple tricks you can use to increase your contribution without hurting your monthly cashflow.
Multiply by 25 for total target
To estimate the total balance of money you’ll need for retirement, the “multiply by 25” rule suggests multiplying your desired annual income by 25. For example, if you want to withdraw $50,000 per year from your retirement portfolio, you need $1,250,000 by the time you retire ($50,000 x 25 = $1,250,000). Keep in mind, that does not consider other sources of retirement income, such as pensions or Social Security.
It also assumes that stocks will produce annual returns of roughly 7% with inflation of approximately 3% per year, so your real return, after inflation, will be around 4% per year.
These rules of thumb provide a simple way to gauge your progress toward a financially sound retirement, but retirement advice is rarely one-size-fits-all. Some people need less income to maintain their standard of living in retirement. Some need more to fulfill their dreams of travel, philanthropy or helping adult children. How much you need to save depends on when you start saving, how you invest, when you retire and how you live after you retire.
Personalizing Your Savings Goals with Retirement Calculators
Rather than relying on a rule of thumb, a good way to get personalized calculations for your retirement savings goals is to use a retirement planning calculator. A number of these tools can be found online.
Thrivent Financial’s retirement planning calculator lets you enter your current age, marital status, desired age at retirement as well as information on your income, retirement savings and expected inflation. The calculator will show the expected value of your retirement assets at retirement and predict how long those funds will last. You can choose to include estimated Social Security income, or leave it out to view results based on your portfolio alone. Full disclosure: we are a division of Thrivent Financial, but we truly do think theirs is one of the best retirement calculators out there.
AARP’s retirement income calculator also lets you enter your marital status, age, current income, and information on your income, savings and desired lifestyle in retirement. You can also choose to add expected income from a pension. The calculator then shows the expected balance you’ll need, the balance you’re projected to have and whether you’re on track.
Each of these calculators allows you to make adjustments to your savings, income, and other variables to see how these changes would affect your outcomes. You’ll see that making small tweaks, like how much you’re saving or your age at retirement, can translate into significant changes in your total retirement savings.
If you’re feeling discouraged because the amount you need to save seems unattainable, don’t worry! Every little bit helps. These calculators are meant to give you a general idea of how savings can build over time, and other assets like emergency savings accounts can make a huge difference. We’ll cover that in the next section.
Liquid Savings vs. Retirement Savings
If you ran some scenarios using a retirement calculator and weren’t pleased with the result, your first instinct may be to start directing every spare dollar into your retirement accounts. But before you make any major moves, consider how much you have in emergency savings.
You see, retirement savings aren’t liquid assets. Liquid assets can be readily converted to cash, without taxes or penalties, if you need money in a pinch. For instance, if you suddenly needed to come up with $1,000 for a home repair, you would be able to access that money in your savings account very quickly.
Why You Should Have an Emergency Savings Account First
Retirement accounts could be an expensive way to get cash. If you withdraw funds from an IRA before the age of 59 ½, you will likely have to pay income taxes on the distribution and possibly an additional 10% early withdrawal penalty.
You may be able to take a loan from your 401(k), but borrowing from your retirement account is highly discouraged. While the money is out of your retirement account, you’ll miss out on the earnings your investments would have produced, likely pay interest on the loan and a loan fee. If you leave your job or are laid off before the loan is repaid, you’ll typically have to repay the loan within 60 days. If not, repayment is typically stretched over five years. If you can’t repay it, the loan is considered a distribution, subject to income tax and a penalty.
For these reasons, it’s a good idea to make sure you have an emergency savings account before you ramp up your retirement plan contributions. Without an emergency fund, small bumps along the road of your financial life can spell disaster. A major home or vehicle repair, suddenly facing a $3,000 medical deductible, or job loss can drain your bank account or force you into debt.
In addition, younger savers may be working toward other goals, such as buying a home, starting a business or paying off student loans. In a perfect world, you’d be able to save for an emergency, a major purchase and retirement all at the same time. If you’re young, consider establishing an emergency fund first. You have time for your retirement savings to catch up.
Determining Income Needed in Retirement
So how do you know that you’ll have enough money in retirement? As mentioned before, eighty percent of your pre-retirement income is often used as a guideline but that’s not a hard and fast rule. So how can you estimate your expenses in retirement? It’s not an exact science, but the best place to start is by looking at your major expenses.
Planning for your major expenses in retirement
The reason the 80% rule doesn’t work for everyone is because your cost of living is not a function of how much you make. Some millionaires live like poor college students. Some college students live like millionaires (until their credit card gets declined). To get started with an estimate of your retirement spending, you first need to know what your major expenses will be, then see how much money you’ll have left over.
- Housing. Housing is the largest expense in most retirees’ budgets. According to the Social Security Administration’s Expenditures of the Aged Chartbook, people age 65 and older spend, on average, $12,981 per year on housing, including mortgage or rent payments, real estate taxes, utilities, maintenance, insurance and furnishings. Housing costs can be reduced by living in an area with a lower cost of living, paying off your mortgage before retirement, or downsizing to a smaller home. If you have a mortgage, plan to pay it off by the time you retire. Adjust your term or loan length to make sure it ends before your desired retirement age and don’t extend your term when refinancing.
- Health care costs. Health care is another major expense during retirement.Health care is another major expense during retirement. Actual costs vary quite a bit, but according to Fidelity Investments, the average 65-year-old healthy couple retiring in 2017 will pay about $275,000 for all of their health care costs in retirement. Dividing that by 20 years works out to an annual cost of not quite $7,000 per person. While we cannot predict future health care needs with absolute certainty, living a healthier lifestyle now may lead to fewer medical bills tomorrow. Maintain a healthy weight, get regular exercise and take advantage of preventative health care services and screenings. These can help you enjoy a longer, healthier retirement. Start establishing a healthy lifestyle now. Trust us, your 65-year-old self will thank you later.
- Food. According to the SSA’s Expenditures of the Aged Chartbook, people aged 65 or older spend an average of $4,555 per year on food, with people age 75 or older spending 95% of their food budget on meals prepared and eaten at home. If you’re planning on eating out at restaurants frequently, that’s something you may want to factor into your planning. Getting in the habit of meal planning and cooking at home is a great habit to develop now and can free up money from your budget to be put toward building an emergency savings or increasing your retirement contribution.
Estimating what your major monthly expenses will be in retirement can help you identify gaps that could be filled by retirement products such as an annuity, which provides a stable regular income during retirement.
Next, we’ll look at how you’ll actually pay for these expenses: your retirement income.
Retirement Savings by Age
The sooner you start saving for retirement, the better. That’s because time is on your side when you’re younger, thanks to the power of compounding interest.
In simple terms, compounding interest means you begin to earn interest on your interest, resulting in your money growing at an ever-accelerating rate. The more money you have earning compound interest, and the longer the time period, the larger your savings can grow.
With that in mind, let’s take a look at how much you should ideally have saved for retirement at each decade.
How much you should save for retirement by age 30
By age 30, you should have the equivalent of your annual salary saved. So if you earn $50,000 a year, you should aim to have $50,000 in savings by the time you hit 30.
To get there, aim to save at least 10% of your income during your 20s. Remember, that 10% is a combination of your 401(k) or IRA contributions and matching funds from your employer. Be sure you’re contributing enough to your employer-sponsored plan to take full advantage of your employer match.
Insider tip: Whenever you get a raise, increase your contribution by 1%. If you receive a 4% raise, and you increase your retirement contributions by 1%, your net paycheck will still be larger, and you’ll probably never miss that extra 1%.
When you’re in your 20s, you likely have 30 to 40 years (or more) to invest before you need that money back, so you might choose an aggressive investment allocation that has higher growth potential but also greater risk. Make sure it’s an investment mix you can stomach. If big losses would freak you out and cause you to move everything to cash, you may be better off with a less aggressive mix.
Don’t fall into the trap of getting more aggressive when the market is up and more conservative when the market is dropping. That’s acting emotionally—precisely the opposite of how you should behave when it comes to retirement savings.
How much you should save for retirement by age 40
By age 40, you should have the equivalent of two times your annual salary saved. You should be saving 10-15% of your income and taking full advantage of your employer match. Continue to increase your retirement plan contributions by 1% every time you get a raise.
At age 40, you still have some time to ride out market fluctuations. As you move through your 40s, your investment mix could start getting a little more conservative. Look for a medium risk/medium return investment allocation.
How much you should save for retirement by age 50
By age 50, you should have the equivalent of six times your annual salary saved. If you’ve saved diligently and increased your savings rate with each raise, compound interest will help you get there.
Continue saving and consider moving some of your savings into a more conservative risk allocation. Your life expectancy is probably another 40 years, so you’ll want to keep your money growing to ensure it lasts your whole retirement.
How can you catch up if you’re behind?
If you’re not as prepared for retirement as you’d like, there are ways you can catch up. Focus on finding ways to save money and add those savings to your retirement account.
You can also plan on putting in a few extra years on the job. Remaining in the workforce gives you more time to save, more time to earn returns and higher Social Security benefits. You could also consider working part time during your first few years of retirement. If you’re age 50 or older, you can also take advantage of catch-up contributions to your retirement accounts by contributing an additional $6,000 to your 401(k) and $1,000 to your IRA.
Retirement Accounts & More
Now that you have some ideas for calculating how much you need to save. The next question is where to stash those retirement savings.
Let’s look at a few popular options:
A popular choice, 401(k) plans are the most popular employer provided retirement plan. There are also other types of employer provided plans. To learn more about the specifies of those, click HERE. Contributions to your 401(k) are pre-tax, so you’ll pay taxes when you take a distribution from your account. Some employers may also offer a Roth 401(k) option. Contributions to a Roth 401(k) are made after tax, so your distributions in retirement are not taxed, unlike a standard 401(k).
You can begin taking distributions from your 401(k) plan once you have stopped working and reached age 55. Your distributions are subject to ordinary income tax. Starting at age 70 ½, if you have stopped working you must begin taking required minimum distributions (RMDs) from your accounts or face a penalty. You can contribute up to $18,000 per year to a 401(k), or $24,000 per year if you are 50 or older.
Many employers that offer 401(k) plans also offer a matching contribution. At a minimum, you should contribute enough to your 401(k) to take full advantage of your employer match. It’s free money!
Individual retirement accounts (IRAs) allow you to contribute up to $5,500 per year ($6,500 if you’re 50 or older). Contributions to a Traditional IRA are tax deductible depending on income and participation in an employer plan, and investment income accumulates on a tax-deferred basis.
You can begin taking distributions from your IRA at age 59 ½. Distributions are subject to ordinary income tax. Beginning at age 70 ½, you must begin taking RMDs from your accounts or face a penalty.
A Roth IRA has one major advantage over a Traditional IRA: they provide tax-free distributions in retirement as long as you are at least 59 ½ and have had a Roth for at least five years.
Unlike Traditional IRAs, contributions to a Roth are not tax deductible. However, you can withdraw your contributions at any time, free of tax or penalties, since no deduction was taken on those contributions. Only the income earned on those contributions is taxed if the income is withdrawn before age 59 ½.
Also, Roth IRAs do not require you to take RMDs. The contribution limits for Roth IRAs are the same as those for Traditional IRAs: $5,500 per year ($6,500 if you’re 50 or older).
Cash in the mattress, bricks of gold or your grandma’s coin collection
Cash is a wise choice for an emergency fund, but it’s a bad strategy when it comes to retirement savings. Why? Because if you don’t invest, you’re actually losing money every year.
On average, the cost of goods and services goes up by about 3% every year due to inflation. If you’re earning just 1% in a savings account, you are losing purchasing power every year due to inflation.
But we get it, maybe you don’t trust banks or are afraid of losing money in the stock market. Just make sure if you are choosing a non-conventional method of savings for retirement that you seek expert advice and that you have a backup plan. Oh, and the Rubbermaid bin full of Beanie Babies in your storage closet doesn’t count as a backup plan.
Monitoring and Maintaining Your Retirement Savings
Whether you feel like you’re on track, ahead or behind in your retirement saving, here are some strategies to help ensure you have enough income for retirement.
- Continue saving. Always pay yourself first and set your contributions as a percentage of your pay so that your contributions will increase as your salary rises. Every time you get a raise, increase your contribution rate by 1%.
- Your investments are likely to change in value over time. As this happens, your portfolio doesn’t reflect your original investment mix, and you may increase the potential for risk. Re-balance your account once a year and review it every three months.
- Don’t stress out about market fluctuations. There may be times when your investments dip in value. Don’t panic. In a majority of cases, market fluctuations are caused by short-term events, such as a sudden change in oil prices. Remember, retirement savings are about the long term. Don’t make investment choices out of fear, or you will lose out on the long-term benefits of the market.
Retirement Considerations for Couples
Married couples need to plan for retirement differently than single people do. By making retirement decisions with a joint outcome in mind, your money can last longer, and you can look forward to a more secure retirement.
Here are a few things to consider when you’re planning for retirement as a couple:
- Lifestyle in retirement. You and your spouse need to be be aligned on when you want to retire and what you want your lifestyle to be like. Having these conversations early and often are important for planning and making a smooth transition into your non-working years.
- Risk tolerance. In many marriages, one spouse is a more conservative investor than the other. Work together to find a comfortable balance between your risk tolerance levels.
- Long-term care. People are living longer, which makes issues like health care and elder care more important than ever. Talk to your spouse about long-term care plans. Will you rely on each other or other family members to provide care? How will you finance long-term care costs?
- Social Security Strategies for claiming Social Security benefits differ drastically for married couples versus single people. For single people, the longer you wait to claim benefits, the more you’ll receive. But Social Security spousal benefits don’t increase after full retirement age. Couples have the option of claiming benefits based on their own work records, or 50% of their spouse’s benefit. Couples with significant differences in earnings may find that claiming the spousal benefit is better than claiming their own. You can run some numbers using a free Social Security benefits calculator like this one from AARP®.
It isn’t always easy for both spouses to be involved in every financial decision, but it’s important for both of you to know about your assets, debts, insurance, property and financial accounts. Both spouses need to know where records are kept and how to access the money. Have regular conversations to make sure you have the information you need, and your retirement goals are aligned.
Stay at home parent? We’ve heard from many stay at home parents that thinking about retirement fills them with anxiety because they are not personally contributing to a retirement account. The most common questions we get is, “What happens if my spouse, the primary wage earner, dies or we get divorced?” If your spouse were to die, you would likely be the primary beneficiary of their retirement account, this is something that your spouse would designate within the account. You would also be eligible to receive their Social Security benefit upon reaching the age requirements. Another way to protect you and your family in the event that a spouse, especially the primary wage earner, passes away is life insurance. What about divorce? State laws vary, but as part of a divorce settlement, the non-wage-earning spouse would likely receive part of the working spouse’s retirement savings.
We never know what the future will hold, but there are things you can do now to maximize your chances of having a happy, healthy retirement.
- Control your spending.Whether you’re in your 20’s or well into your retirement, living within your means is the single biggest step towards making sure you never outlive your money.
- Have a plan.Devising a plan before you retire relieves stress once you’re retired. Figure out how your retirement accounts will translate into monthly income and how much you can expect from Social Security, and create a budget for expenses.
- Stay engaged and healthy.The happiest retirees are ones that are engaged in some kind of meaningful activity. Becoming an entrepreneur, continuing to do paid work, volunteering for a good cause, or taking up hobbies can help you remain active and engaged. To increase your chances of a healthy retirement, eat well, get enough sleep, exercise regularly and maintain strong social connections.
- Minimize debt.Reduce or eliminate any debt you can before you retire. If you take out a mortgage, the term of your mortgage should ideally be the same length or shorter than the number of years you have left on your current mortgage. For instance, if you are 45 and you plan to retire at 65, don’t take out a mortgage longer than 20 years.
- Be Awesome. Whatever that means to you, do it. Whether it’s philanthropy, volunteering, taking care of your grandchildren, traveling the world or just kicking back with a beer and working on old cars. Put in the effort now so that you can be the best version of yourself in your golden years.
Do I Need a Financial Advisor?
Some people enjoy planning for retirement. They find research, calculations and allocations fun. If that’s not you, you may want to consider working with a financial advisor.
Financial advisors can help you set financial goals and priorities and recommend specific steps to meet your goals. They can give advice on investment allocation, what kind of insurance you need, and how certain moves will affect your taxes. Their advice can be especially helpful if your situation is complex, involving, for example, a child with special needs, a second marriage, or rental properties.
Of course, that advice comes with a fee. The fees financial advisors charge can vary greatly depending on whether the planner is commission-based, fee-based or fee-only. Before you hire a financial advisor, ask about their fee structure and get an idea of what their advice will cost you. Fees are an important consideration, but keep in mind that sound investment advice can offset those fees for years to come.
Whether you do the number crunching on your own or hire a pro, you need to assess your progress toward retirement savings on a regular basis. Otherwise, you run the risk of finding out late in the game that you’re not nearly as prepared for retirement as you thought.