The cost of living continues to rise, people are living longer and company pensions are virtually extinct. What does this mean for your money?
For one thing, it’s more important than ever to save for retirement, but not just by throwing money away here and there, hoping it’ll be enough when you’re ready to leave the workforce. That money also has to grow over time to keep up with inflation.
A diversified investment portfolio can help you protect the value of your money as you age, reducing the risk of running out of retirement funds.
“The earlier you get started, the more your money will work for you,” says Sri Reddy, senior vice president of retirement and income solutions at Principal Financial Group.
So don’t wait. If you start saving $100 a month with an average annualized return of 6% on your investment, you would have about $46,000 in 20 years. But if you wait 10 years to start saving and investing the same amount, you’ll end up with only $17,000 in two decades, since you’ve lost some of that initial compound growth.
Here’s how much you should save for retirement and how to get started.
Maximize your Social Security benefits
Social Security is an insurance program administered by the federal government that provides income benefits to retirees, certain dependents of beneficiaries, disabled persons, and qualified survivors of deceased workers. According to a 2020 report from the think tank National Institute on Retirement Security, 40% of older Americans rely completely on Social Security income in retirement to meet all of their expenses.
Once you turn 62, you are eligible for Social Security if you have enough “work credits,” which you earn each year based on your annual income. Eligibility for most retirement benefits requires that you have earned a credit on average for each year between ages 21 and 62, according to the Social Security Administration (SSA).
Although you are eligible to claim benefits when you turn 62, your monthly check will be about 30% less than if you wait until full retirement age (66 if you were born between 1943 and 1954, and will gradually increase until 67 if you were born between 1955 and 1960: find your retirement age here). Once you reach full retirement age, you will receive 100% of your earned benefits. But if you can hang on until you’re 70, you’ll reap 24% to 32% Moreover higher than your benefit at full retirement age.
While you can wait until age 70 for a larger check, Social Security shouldn’t make up your entire retirement income plan. According to the SSA, retirees receive an average of 40% of their pre-retirement income through the program. So make sure you save elsewhere.
How much should I save for retirement?
The amount to set aside for retirement varies from individual to individual and depends on various factors. First, you’ll want to consider the age you want to retire and your desired lifestyle.
“People’s opinions on what they want to do in chapter two vary very drastically,” Reddy says.
But you don’t have to be certain about your future to make a plan. If you want to have a retirement lifestyle consistent with what you’ve had throughout your career, financial services firm Fidelity’s rule of thumb is to try to save 10 times your income by age 67. This means saving your income once. salary by age 30, three times your salary by age 40, six times your salary by age 50, and eight times your salary by age 60.
Keep in mind that all the planning in the world won’t make up for unexpected events, like losing a job, getting a divorce, or health problems. Have a plan and work toward a goal, but recognize that it’s OK if it goes off track, Reddy says. When this happens, he recommends reevaluating your income, savings, prospects and future goals.
You may need to readjust your plan by postponing your retirement date or opening a long-term care insurance policy to help cover the costs of extended health care.
If you have trouble coming up with a plan on your own, you may want to hire a financial advisor who can help you.
How much of my income should I save for retirement?
Once your paycheck hits your bank account, it can be difficult to part with. If you have a retirement account like a 401(k), it’s best to automatically transfer some money into your retirement account before you can touch it. Fidelity recommends saving 15% of your income to reach that 10x salary savings goal by age 67 (which includes the employer match).
That 15% might seem like a lot, especially when you’re just starting your career and juggling other financial priorities. It’s important to save what you can as early as possible and try to increase that percentage over time, says Melissa Ridolfi, vice president of retirement and college planning at Fidelity Investments. So, if you’re starting with a 401(k) contribution that doesn’t get you to the 15% total, try increasing it every year or whenever you can afford it.
And remember that once you enter the workforce after college, your income will likely continue to increase, but that doesn’t mean you should continue to increase the cost of your lifestyle, Reddy says. The more you prioritize things like upgrading your car or home, the more you’ll need to save for retirement to keep up with that kind of lifestyle.
“Enjoy life,” Reddy says, but if you get a 3% to 4% raise, you should pocket 1% to 2% and put the rest into savings.
Where should I put my retirement savings?
Saving so much for the future might seem overwhelming, but there are tools to help you. Tax-advantaged retirement accounts can help you make the most of your savings. Some are linked to your employer, while others are linked to you individually and follow you throughout your career.
An employer-sponsored account, such as a 401(k), allows savers to invest dollars tax-deferred and postpone paying taxes until they withdraw money from the account as a retiree. Many employers offer a matching contribution, so if you contribute 3%, for example, the company will also contribute 3%. Everyone should contribute at least enough to get the maximum return from their employers, Ridolfi says.
“If you don’t, it’s like leaving free money on the table,” he adds.
Over time, try to contribute a higher percentage of your income to your 401(k), even if your employer only matches up to a certain point.
If you’re a gig worker or otherwise don’t have an employer that offers a 401(k) benefit, an individual retirement account (IRA) might make sense for you. With a traditional IRA, you contribute pre-tax dollars, while with a Roth IRA you pay taxes upfront and withdraw money tax-free in retirement. You can open these accounts quickly and easily, either with an online financial institution or a traditional bank.
If you’re early in your career and believe you’ll earn more later in life, a Roth IRA may be your best bet. That way, you pay income taxes when you’re in a low tax bracket and can take advantage of tax-free withdrawals when you’re (presumably) in a higher bracket later in life.
Your employer may also offer a high-deductible health insurance plan with a health savings account, or HSA, which Reddy recommends taking advantage of. You can make tax-deductible contributions to these accounts to help pay for medical expenses out of pocket. And once you turn 65, you can make withdrawals for qualified medical expenses tax-free, giving you an even greater tax advantage than a 401(k) or IRA.
Overall, it’s about knowing your options and choosing the ones that make the most sense for you.
“Having a plan is the most important thing you can do,” says Ridolfi. Decide how much you will save, how you will save, and increase those savings when you can.
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