UPDATED: April 21, 2022
Retirement is a beautiful transition from work to new adventures. That’s the fun part. Getting in the position to retire is a different kind of journey, which is where our complete guide to retirement savings comes in. With a little planning and the right money habits of saving for retirement, you’ll be living your definition of a fulfilling retirement.
This is our complete guide to all things retirement savings to get your mind and financial decisions moving in the right direction.
Table of Contents
The Fundamentals of Saving for Retirement
If there were a master class on saving for retirement, these would be the core concepts.
- Start Early: The traditional retirement age of 65 might feel a lifetime away if you’re in your twenties, thirties, or even forties. By saving at a young age, you can take advantage of time and compound interest to supercharge your retirement nest egg.
- Make a Plan: The odds are less favorable that you’ll stumble into a comfortable retirement without a plan. You’ll want to get clear on where you want to live in retirement, how much you’ll need to retire, how much you need to save per year, what investments you’ll use, and when you’re going to retire.
- Save Often: Start early and save often. A little bit is better than nothing. Begin to develop good savings habits by putting away money today. Set up recurring contributions every week or month for seamless consistency.
- Account Types: Weigh the benefits of each kind of retirement account and choose those that best support your goals. Does your 401k offer an employer match? Do you qualify for a Roth IRA? What are your retirement options if you’re self-employed? These are the questions you need to answer to optimize your retirement savings plan. Ideally, a retiree would have a mix of pre-tax and tax-free retirement savings.
- Investment Approach: You’ll want to balance generating a return with your capacity for risk. Diversification can help smooth out returns and mitigate portfolio risk. Before retirement, it’s common to take large risks with small amounts of capital. When you retire, you’ll be taking small risks with large amounts of capital.
- Choosing a Place to Retire: Relocating in retirement can make a huge difference in a retiree’s personal and financial life.
How Much Money Do I Need To Retire?
There are several contributing factors when you begin to look at how much money is required to retire. Here are questions to ask yourself that can guide you to your personal retirement number.
How Much Money Will You Need to Fund Your Lifestyle?
Monthly spending can vary dramatically based on the kind of lifestyle you want in retirement.
- $5,000 per month in the Hampton’s doesn’t go very far.
- $5,000 per month is rural Kansas might be extravagant.
When trying to land on a retirement number, start with where you live and what you like to do. You’ll likely back-in to a reasonable estimate for monthly and annual expenses.
How Much Income Will I Have?
- Will you receive a pension from your employer?
- Will you begin to take social security benefits when eligible?
- Do you have rental income or money from other passive investments?
It’s important to understand how much of your retirement income is NOT tied to financial markets (Social Security, pension, real estate income).
You can subtract these amounts from the amount you plan to spend monthly, indicating how much, if any, you’ll need from your investment portfolio. In general, the more income you have not tied to financial markets, the more flexibility you have in building an investment portfolio. For example, if you have income to cover all of your expenses, you could make the case to build a conservative portfolio or an aggressive portfolio. The determining factor would be your personal risk capacity.
Additional Considerations For Retirement Savings
There are several other considerations when evaluating how much money you’ll need for retirement.
- Medical insurance/Long-term care: According to the Department of Health and Human Services, approximately 70% of older adults turning 65 today will need long-term care at some point in their lifetime. Most older adults will qualify for Medicare, but it’s worth thinking about how you’ll pay for specialized care beyond the scope of your medical plan.
- Leaving a legacy: If you have children or grandchildren, you may want to leave money for a college education, first-home purchase, or a head start on their own retirement savings.
If you have a specific amount you would like to leave to your heirs, you can bake that into your retirement savings plan. The other approach is the next generation gets what you don’t use. It’s important to take care of your own retirement security first.
Calculating How Much You Need To Retire
One method to figure out how much you’ll need in retirement is to use an online calculator. Most retirement calculators require standard inputs to provide an estimate of needed retirement income.
- Current age
- Desired retirement age
- Savings rate
- Existing retirement savings amount
- Estimated rate of return
- How much money you want to have in retirement
A retirement calculator can highlight potential gaps between what you’re projected to have in retirement vs. what you’ll need.
The long-term growth of investments is dependent on your savings rate, return assumption, and time invested.
Finance experts insist that a safe projected rate of return is around 6%, with 8% being optimistic. When penciling out your retirement plan, it’s better to use a conservative estimate to give yourself a margin of safety. A bulletproof retirement plan is favorable regardless of how financial markets perform.
It’s better to err on the side of low returns when modeling retirement scenarios.
Where Should I Save Money?
There are many investment vehicles specifically designed for retirement savings.
- Tax incentives: Depending on the type of account and whether your contributions are pre or post-tax, you will either receive the benefit of tax-deductible contributions today or tax-free distributions in the future.
- Investment options: No matter the type of retirement account you choose, you will have ultimate say over the way your money is invested.
- Within a company 401k plan, you will be limited to their menu of funds. However, in a self-directed IRA, you will have almost unlimited access to stocks, bonds, ETFs, mutual funds, etc. to build your own portfolio.
- The 2022 limits for 401k contributions are $20,500 if under 50 years of age.
- If you’re 50+, you can save a total of $27,000. The limits do not apply to employer matching contributions.
- Saved the max? Congratulations! You can still sock away money in a taxable brokerage account. After-tax money goes in and can be accessed at any time. Be mindful of taxable investment income (dividends and bond interest) and capital gains tax.
Retirement Investments Not Tied To An Employer
While several retirement vehicles are dependent on your employment situation, there are some that everyone can utilize.
- Individual Retirement Account (IRA) or Roth IRA: IRAs are investment vehicles that anyone can open. The traditional IRA is an investment option that offers a pre-tax contribution opportunity, while the Roth IRA is funded with after-tax dollars.
The contribution limit in 2022 is $6,000 for individuals under 50 and $7,000 for those 50 or over. It’s important to note that this contribution limit is for both the traditional and Roth IRA. So if you elect to have both, you’ll need to split funds accordingly.
- Brokerage Accounts: There are no restrictions on a brokerage account for contributions or withdrawals, making it an excellent opportunity to invest for retirement. But you’ll also want to be cognizant that there are no tax breaks on this type of account.
|Type of Account||Advantages||Disadvantages|
|Traditional IRA||Contributions may be tax-deductible if qualifications are met. Anyone with taxable income under age 70 ½ qualifies.||Required minimum distributions apply after age 72.|
|Roth IRA||Tax-free growth. Access to principal contributions without penalty before age 59 ½ .||Income limits apply.|
|Taxable Brokerage Account||No penalties for withdrawing money.||No tax shelter benefits.|
Retirement Vehicles For Traditional Employees
The following are common types of employer sponsored retirement plans.
- 401(k): The 401(k) is the classic retirement investment vehicle for employees at for-profit organizations. Contributions can be made pre or post-tax (Roth 401k), with most employees opting for automatic contributions before the money ever hits their bank account.
- 457: A 457 is similar to a 401(k) but offered specifically to government employees and certain nonprofits. Like the 401(k), contributions can be made either pre or post-tax.
- 403(b): The 403(b) plan is most commonly offered to public employees, and other tax-exempt organizations. The 403(b) is similar to 401(k) or 457 plans. In some cases, 403(b) plans offer a narrower menu investment choices due to union relationships with financial institutions.
Retirement Vehicles For The Self-Employed
There are plans designed specifically for the self-employed that offer tax-sheltered retirement savings.
- Solo 401(k): The Individual or Solo 401(k) allows individuals who are self-employed with no employees, except for their spouse, to contribute to the plan as both the employer and employee. With contributions that are deductible as a business expense and high employer contribution limits (up to $57,000 in 2020), the Solo 401(k) is a popular choice for individually owned and operated businesses.
- SEP IRA: The Simplified Employee Pension Plan, or SEP, is a business plan that only allows employer contributions. The contribution amounts are flexible each year, so it primarily serves small businesses who may have volatile revenue. 2022 contributions made by employers cannot exceed the lesser of 25% of an employee’s compensation or $61,000.
- Simple IRA: The Savings Incentive Match Plan for Employees, often recognized as a SIMPLE IRA, allows small businesses to set up either an employer match up to 3% or a 2% non-elective contribution. Either way, the SIMPLE IRA is an excellent option for small businesses that want to offer a benefit without the administrative costs of a 401(k) plan.
How Much Can I Save?
Now that you understand the retirement vehicles available, it’s time to start thinking about filling each bucket you plan to use. That begins with determining how much you can save regularly.
While a general rule is to save as much as possible, that can be challenging, especially if you’re living paycheck to paycheck. Use these tips to maximize the amount you can save each month without crimping your lifestyle.
- Assess your current spending: If you’re wondering where extra retirement savings might come from, establishing a household budget is a must. You can’t make progress if you don’t understand where you’re at.
- Look at retirement calculations with changing inputs: Use a retirement calculator, tweaking the inputs to view the impact of additional savings. It’s incredible how quickly the projected asset base can increase as you add more money to your annual contributions. Many people obsess over generating investment returns. Most would be better off maximizing their savings rate.
How Can I Boost Retirement Savings?
- Rely on automation: Employer-sponsored retirement plans are often easier to contribute to since pre-tax contributions are taken out before it shows up in your bank. By automating a set amount or percentage of income to a retirement account each month, you’re taking the friction out of saving.
- Get the match: The most significant benefit to an employer-sponsored retirement plan is that many offer to match contributions up to a certain point. If your employer matches contributions up to 3%, it’s critical to save at least 3% of your earnings to get the full match. Failure to contribute up to the employer match is the equivalent of throwing away free money.
- Catch-up if you need: For individuals over 50, there are higher catch-up contribution limits to enable you to save more. These catch-up contributions can amount to several thousand extra dollars per year, depending on your income.
- Seek professional help: Feeling overwhelmed? You’re not alone. The right financial advisor can help build a retirement plan, manage your investment portfolio, and help with taxes/estate planning. Be sure to look for a fiduciary who is obligated to act in your best interests and has low fees. Hint: Don’t walk into your bank and ask for their financial advisors.
How Can I Access My Retirement Savings Early?
While your best bet for a healthy retirement nest egg is to let retirement savings grow, life happens. If you need to tap retirement funds before age 59.5, here’s what you can do.
- Exhaust your options: Use all other forms of money available to you from savings before pulling from a retirement account.
- Assess the circumstances: Some plans allow for a hardship withdrawal if your need meets specific criteria. According to the IRS, the withdrawal amount is limited to the funds necessary to meet an immediate and heavy financial burden. These qualifying hardship withdrawals will not incur the standard 10% early withdrawal penalty, but you could owe tax on any distributions.
- Look at your Roth IRA: If you’ve been contributing to a Roth IRA for at least five years, you may be able to take out contributions (not growth) without an early withdrawal penalty.
- 401k Loan: Your employer sponsored 401k plan might offer 401k loans. You wouldn’t trigger a 10% penalty or taxable event as long as you pay the loan back with interest. The interest isn’t paid to the bank, but rather to yourself. The downside is the money is no longer compounding in financial markets, but this could be a reasonable option for a short-term cash need.
A Point of Caution when Drawing on Retirement Savings Early
It’s important to note that if you take a distribution from any retirement account before you’re eligible, you’ll want to do everything in your power to return the money as quickly as possible. Any money you pull from a retirement account before the designated time loses its growth potential.
This is especially true if you’re younger and using a hardship withdrawal to fund a home purchase or pay an educational expense. Failure to repay those funds timely could mean several more years you’ll need to work to hit the same retirement goal.
When Do I Begin To Withdrawal Retirement Savings?
At age 72, 401k and Traditional IRA accounts will be subject to a required minimum distribution (RMD). There are somewhat complex requirements for calculating distributions, so it’s best to work with a qualified tax advisor to nail down the specifics.
If the appropriate distribution is not taken, you may face an excise tax of up to 50%. So before you reach retirement age, be sure to understand when and how much you’ll need to withdraw.
The only retirement vehicle that does not require a mandatory distribution is the Roth IRA. With the Roth IRA, distributions do not need to be made as long as you live, and funds will be disbursed tax-free to your beneficiaries upon your death.
How Can I Make My Money Last?
Many people fear running out of money before they die. With people living longer than ever, let’s ensure you live the life you want while being financially responsible.
- Account for inflation: There’s two sides to the inflation equation; modeling household expenses going up over time and building an investment portfolio that exceeds the annual inflation rate.
- Manage expenses: The most common retirement mistake is overspending or not having a good handle on what’s going out the door. This can be a double headwind if you’re overspending and your investment portfolio suffers a period of losses. Create a budget and make sure reality aligns with your financial plan.
- You can still earn: Many retirees still want to live meaningful, productive lives. Find a passion hobby. Create a side hustle. There are many different avenues for generating passive income in 2022.
- Decrease your cost of living: While certain climates are alluring, some areas have a lower cost of living, making them extremely attractive to those on a fixed income. You’ll also want to consider the amount of taxes you pay for everything from property taxes to groceries.
Beyond The Financial Plan
As you look towards a stable retirement, it’s critical to understand that the transition to retirement is much more than figuring out where your money will come from.
Retirement is a significant life change in which you’ll need to establish a new identity, daily habits, and mindset. All of your hard work of saving for retirement is meant to create your best life.
Stay curious, active, and healthy.