Retirement is a beautiful opportunity to move on from whatever line of work you’re in and seek new adventures or simply find time to relax. But planning and saving for retirement is a massive undertaking. We’re here to offer a complete guide to all things retirement savings to get your mind and financial decisions moving in the right direction.
In this article, we’ll cover:
- Retirement savings fundamentals
- Determining how much you need to retire
- Where you should save money
- Non-employer retirement vehicles (IRA, Roth IRA, brokerage accounts)
- Employer retirement vehicles (401(k), 457, 403(b))
- How to boost retirement savings
- Accessing retirement funds early
- How to make your savings last
The Fundamentals of Saving For Retirement
Retirement is something each of us hopes to do, yet there is no formal education on the topic. 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 million years away if you’re in your twenties, thirties, or even forties. But by beginning saving for retirement at a young age, you can take advantage of decades of compound interest. Ultimately, this means that you’ll need to put less money away if you start to save in your twenties than if you were to begin in your fifties.
- Make a plan: The odds are not favorable that you’ll stumble into a comfortable retirement without a plan. You’ll want to get very clear on how much you’ll need to retire, how much you plan to invest, what investments you’ll use, and when you’ll pull out money.
- Save often: Even if it’s only $5 a month, a little bit is better than nothing. Begin to develop a good savings habit by putting away some money today and committing to that amount each week or month.
- Invest wisely: Be sure to weigh the benefits of each kind of retirement account to which you have access and choose those that best support your goals. You’ll also want to check the fees on retirement accounts. If you’re making minimal contributions on a high-fee account, the contributions may be eaten up before they have a chance to grow.
- Diversify: The best retirement savings approaches use multiple investment vehicles and balance pre and post-tax contributions. In addition to savings, you’ll want to assess alternative streams of income. Investing in retirement vehicles is necessary, but don’t discount the benefit of real estate or other passive-income generating investments.
How Much Money do I Need to Retire?
As with so many personal finance questions, the answer is not one size fits all. There are several contributing factors when you begin to look at how much money is required to retire.
Below are some questions to ask yourself that can guide you to your overall retirement number.
How Much Money to Fund Your Lifestyle?
Monthly spending can vary dramatically based on the kind of lifestyle you want in retirement. Some people are perfectly capable of living on $25,000-30,000 per year. Others who live more extravagantly may need upwards of $100,000 per year. Specific elements to consider when you think about lifestyle are travel, vacations, and household 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?
You can subtract these amounts from the amount you plan to spend monthly, indicating you’ll need to rely that much less on your retirement investments for income.
Additional Considerations for Retirement Savings
While the apparent goal of retirement savings is to enable you to live the lifestyle you want without needing full-time employment, there are several other considerations when you look at how much money you’ll need to have available.
- 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 catastrophic care beyond the scope of your chosen medical plan.
- Leaving a legacy: If you have children or grandchildren or plan to one day, you may want to be able to leave a bit of money on top of what you intend to enjoy during retirement. Unless you want to leave children the leftovers, figure out a number and plan to add that to your needed savings.
Calculating How Much You Need to Retire
With this information in mind, the simplest 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. These inputs are:
- 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 raise awareness of potential gaps between what you’re projected to have in retirement vs. what you say you’ll need according to lifestyle.
In the example above, a 30 year old looking to retire at 65 faces a gap of around $1600 per month. This presents an opportunity to figure out how to boost retirement savings to more closely align the projected monthly retirement income with the desired monthly retirement income.
One of the most complicated and most critical elements of a solid retirement plan is your projected rate of return. The long-term growth of investments is entirely dependent on how much you think your savings will make over the years. When you have a time horizon of 30-40 years or more, it’s complicated to try and guess how your investments might grow.
Finance experts insist that a safe projected rate of return is around 6%, with 8% being highly optimistic. If you’re more of an under-promise and over-deliver person, you could use a projected rate of return of about 4% and use anything over that to hit retirement goals faster.
It’s far better to hope for the best but plan for the worst than to bank on a 12% return and reach retirement age only to find out the market had different plans.
Where Should I Save Money?
There are many investment vehicles specifically designed for retirement savings. There are several reasons to use these retirement savings accounts over your local bank’s simple savings account.
- 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-free contributions on the front end or tax-free growth.
- Penalties for dipping in early: Retirement savings should be used for retirement. And the structure of accounts and associated penalties encourage you to leave the money growing into the account until you planned to use it.
- 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.
Retirement Investments Not Tied to an Employer
When it comes to retirement investment vehicles, the options are many. 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 with taxable income can open. The traditional IRA is an investment option that promotes a pre-tax contribution opportunity, while the Roth IRA is funded with after-tax dollars. The contribution limit in 2020 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 plans are what often come to mind when people think about employer retirement accounts.
- 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, with most employees opting for pre-tax withholding’s before the money ever hits their paycheck. Funds in a 401(k) cannot be used without penalty until age 59.5. In 2020, employees can defer compensation up to $19,500 per year to a 401(k), 457, or 403(b).
- 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 teachers and churches and differs a bit underneath the hood from a 401(k) or 457. The plan is tax-sheltered but frequently utilizes an annuity as the investment vehicle instead of mutual funds.
Retirement Vehicles for the Self-Employed
For many people who choose to start a business, just trying to stay afloat is complicated enough. But when you’re relying on yourself to supply income, it means you’re also self-reliant for retirement savings. The tools outlined below were designed specifically for the self-employed and offer tax-sheltered 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 not be making steady profits yet. The employer can contribute up to 25% of each employee’s pay.
- 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% nonelective contribution. Either way, the SIMPLE IRA is an excellent option for small businesses that want to offer a benefit without the expensive fees of an established 401(k).
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. And 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 to determine, especially if you’re living paycheck to paycheck. Use these tips to lock down the amount you can save each month.
- Assess your current spending: If you’re wondering where extra retirement savings might come from, it might help to establish a spending plan or budget. Simply packing lunch to bring to work two days a week could be a quick $15 a week or $60 a month towards retirement.
- Look at retirement calculations with changing inputs: Using the same retirement calculator, you can change the inputs to view the impact of additional savings. It’s incredible how quickly the projected monthly income can increase as you add more money to your annual contributions.
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 you’re aware of how much money you might have had. By automating a set amount or percentage of income to route to a retirement account each month, you’re taking the guesswork out of saving.
- Get the match: The most significant benefit to an employer-sponsored retirement plan is that many employers offer to match contributions up to a certain point. If your employer matches contributions up to 3%, it’s critical to put at least 3% of your earnings into the retirement account to get the full match. Failure to contribute up to the match point 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 the closer you get to retirement. These catch-up contributions can amount to several thousand extra dollars per year, depending on the plan type.
- Seek professional help: A financial advisor may help you find ways to increase savings where you couldn’t see them before. Be sure to look for a fiduciary who is obligated to act with your best interests at heart. Be wary if you start getting a sales pitch about financial products you may not need.
Can I Access My Retirement Savings Early?
While your best bet for a healthy retirement nest egg is to let retirement savings grow until you’re into your 70s, life happens, and sometimes unexpected expenses require more cash than you have on hand. If you’re in dire straits and need to borrow against retirement, 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. A solid retirement plan should outline a way to bridge the income gap until you hit 59 ½.
- 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 need. These qualifying hardship withdrawals will not incur the standard 10% early withdrawal penalty.
- 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.
- Take a withdrawal as a last resort: If you have no other options, you can look to take a loan or distribution and face a minimum 10% penalty.
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?
Certain accounts will force what’s called 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, it pays 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?
While many people fear running out of money before they die, the likelihood of doing so is relatively minimal, assuming you are taking reasonable withdrawals. If you have a large enough nest egg, withdrawals may be less than or equal to the interest earned in any given month. But there are a few guard rails you’ll want to put in place to make sure you don’t risk running out of money before you run out of time.
- Account for inflation: If you plan to take out 4% of your investments annually (often considered an average amount), you’ll want to be sure that 4% increases to account for inflation over the years. If you plan to retire at 65 and want to ensure enough money until 95, that’s another 30 years for money to grow and inflation to continue.
- Keep withdrawals consistent: A surefire way to blow the retirement plan is to dramatically increase spending outside of your previous plan constraints. If your savings calculations plan on a monthly withdrawal of $3,000, but you suddenly decide you’d be more comfortable at $6,000, your money is going to last half as long as anticipated.
- Consider other income for discretionary spending: If you’re planning to retire but still want to work, consider using that income for your day-to-day spending and allow retirement savings to grow. The longer you can delay dipping into the nest egg, the better off you’ll be.
- Decrease your cost of living: While certain climates are alluring (hello, Florida!), 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 your house to groceries, as these can add up quickly in some expensive areas.
Beyond the Financial Plan
As you look toward a stable financial future in retirement, it’s also critical to understand that the transition to retirement is so 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, set a new schedule, and seize the opportunities the next chapter brings. All of your hard work of saving for retirement is meant to create the possibility for you to live exactly how you want.
Saving for retirement is an extraordinarily tricky but necessary part of your financial life. The time you spend on the front end developing a retirement plan is guaranteed to pay dividends on the back end.
Once the plan is in motion, it only takes a quick peek at your accounts throughout the year to make sure you’re on track. Your retirement plan doesn’t need to be overly fancy, but it does need to work for you and your goals.