Saving enough funds for retirement is no mystery. The more you save each year to cover your estimated retirement expenses and future health care costs, and the sooner you start, the better. But how much is enough, how do you set a retirement savings goal and how much do you need to put aside each month to reach your goals? And is it ever too late to start your retirement savings or are catch-up contributions possible? Let's put retirement planning in perspective.
How Much Retirement Income Will You Need?
According to AARP and other retirement planning advisers, you'll need about 80 percent of your current income to support yourself in a comfortable retirement. The 20 percent difference is roughly the amount of state and federal income taxes and other payroll taxes that will not be deducted from your retirement income.
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Of this target 80 percent income level, you can expect to receive about 40 percent from your Social Security benefits and another 40 percent from your retirement savings accounts.
Let's say you retire with an income of $6,000 per month. Your target retirement income would be $4,800 per month (80 percent of $6,000).
How Much Do You Need to Save?
Fidelity Investments recommends that you save 15 percent of your pre-tax income each year in a retirement account. This 15 percent goal includes any employer match contributions made by your employer, so not all the savings have to come from your income. If you plan on retiring at age 67, the goal is to have 10 times your current income in your savings accounts.
In order to reach this final retirement goal, your retirement plan should be to have three times your income by age 40, six times your income by age 50 and eight times your income by age 60.
What If You’re Behind on Your Retirement Plan?
The best plan is to start your retirement savings plans as soon as possible, but not everyone does that. What if you don't start putting money aside until later in life? How will you catch up?
The answer is that every little bit in additional savings helps. Fidelity Investments has a calculator that shows the additional contribution of just adding 1 or 2 percent to your savings rate, depending on your age.
Suppose, for example, that you're 40 years old, have a current income of $50,000 per year and plan on retiring at age 67. According to the Fidelity calculator, if you increase your savings rate by 1 percent, your retirement savings at the age of 67 would increase by $47,550. If you were able to save an additional 3 percent, your retirement savings would be higher by $118,875.
But what if you've waited until age 50, and you've put aside some funds for retirement but not enough? Suppose you're now making $60,000 per year and still want to retire at age 67.
Even starting at this late stage of life, putting aside another 3 percent of your income would increase your retirement savings by $65,276. And if you could put aside 5 percent, you would have an additional $112,546 in retirement savings.
How to Save For Retirement
The best way to accumulate funds for retirement is to take advantage of the various tax-deferred investment vehicles. Here are the most popular:
Individual IRA - You can open an individual retirement account (IRA) at banks, credit unions and other financial institutions. Contributions to an IRA are deductible on your tax return up to $6,000 per year. Earnings on dividends and capital gains are not taxed until you begin to withdraw funds in retirement.
Roth IRA - While contributions to a Roth IRA are not tax-deductible, you can make withdrawals without paying any income taxes. In addition, investment gains in a Roth IRA are not taxed. You can contribute up to $6,000 per year to a Roth IRA.
401(k) - Many employers offer 401(k) retirement plans where you can make pre-tax contributions up to $19,500. If you're over age 50, the contribution limits rise to $26,000. In many cases, the employer will match your contribution up to a certain amount. Withdrawals are subject to taxes.
Roth 401(k) - Some employers offer a Roth 401(k) where you make contributions after tax. This type of account works best for people who believe they will be subject to higher income taxes in retirement than their current tax bracket.
It's never too late to start saving for retirement. With compound interest, saving even small amounts can add up to a substantial investment over several years.
- USA.gov: Retirement
- AARP: How Much Money Do You Need to Retire?
- Internal Revenue Service: Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits
- SoFi: Understanding the Different Types of Retirement Plans
- U.S. News: Retirement Accounts You Should Consider
- Forbes: How Much Should You Save For Retirement?
- Fidelity: See How a Small Change Can Make a Big Difference