One of the most common questions a financial advisor hears is, “Am I saving enough for retirement?” This seems to be at the top of people’s minds, especially as they get older. Because every person’s dreams and goals are different, there’s no one-size-fits-all answer. However, there are three things that everyone should be doing to get as close as possible to the goal of having enough money for retirement.
Aim to Save 15% of Income
It’s important to have a specific goal when saving for retirement, so you have something to work towards. Generally speaking, it’s recommended to save 15% of your pre-tax income toward retirement. That is $15,000 for every $100,000 you make a year. (For more, see: 10 Steps to Retire a Millionaire.)
While the earlier and the more you save the better, 15% is a reasonable number for most people to fit into their budget. It works well because it is enough to build a nest egg, but not so much that it will hurt you in the present.
For many people, their only goal is to contribute up to the match on their company’s 401(k) plan. While this is a good goal, it is not enough. You can’t assume that just meeting the match will be enough to build a sufficient nest egg.
Not only is contributing up to the match not usually enough, but sometimes even maxing out your company’s retirement plan isn’t enough. The annual contribution limit on a 401(k) plan is $18,000. If you make over $120,000 a year, a 401(k) alone won’t be enough to get you to 15%. You will need to save elsewhere as well, like in a Roth IRA (if eligible) or even a taxable account.
Don’t assume that since you’re maxing out your company plan that you’re saving enough. While it may be enough for some people, if you’re used to a higher standard of living because of your higher salary, you’ll need more savings. Instead of focusing on specific accounts, focus on saving 15%.
Invest Your Savings Intelligently
Although 15% is an important goal to shoot for, how that money is invested and the vehicles used are of equal importance. You’re working hard to save all that money, so don’t let your efforts go to waste by not handling it wisely.
One of the biggest investment mistakes an investor can make is investing long-term money too conservatively. While your risk tolerance is an important factor in choosing an investment, it’s important to know the trade offs, because all investments are not created equal. And the longer your time horizon, the greater the inequalities grow. (For more, see: Not All Retirement Savings Accounts Should Be Tax-Deferred.)
For example, let’s say you are going to invest $15,000 a year for 30 years. If you put it in a fixed investment earning 2% a year, you will end up with $620,000. That may not sound bad, but let’s take a look at the trade off. If you were to invest that same money in equities earning 7%, you would end up with $1,520,000. That’s a $900,000 difference.
Rates of return will have a great impact on the amount that you are able to accumulate, but so will the kind of investment vehicles you choose to use. Your savings will probably be much more effective if put them in a Roth account instead of a regular account.
If you choose to use a Roth 401(k) instead of a regular one, there will be a difference in your take-home pay. Roth investments are post tax, while regular 401(k)’s are pre-tax, so you will take home less with a Roth. However, when it comes time to withdraw your money, there will be a difference as well.
Remember our example above, with $15,000 invested annually over 30 years into an equity investment earning 7%? Had that money been invested in a Roth 401(k), the $1.5 million would be tax-free upon withdrawal. If it were in a regular 401(k), the $1.5 million would be taxable as you withdrew your money. That’s a huge tax savings just for using a different kind of retirement account.
Do the Math
If you’re wondering if you’re saving enough for retirement, the better question to ask is have you ever calculated just how much money you will need in retirement? Have you ever taken the time to sit down, look at the numbers, and do the math to come up with a target nest egg?
You should. Simply knowing how much money you need can be a strong motivator to increase your savings habits. This can be huge if you have a long time to save for retirement. Calculating the numbers to see how much accumulated interest will contribute towards your nest egg instead of having to save it out of your income later in life can be mind boggling. Continuing the above example, if you waited 10 years to begin saving, you would have to set aside over twice as much per year to end up with the same amount of money!
If you’re doing all that you can to save, but still don’t feel that you’re saving enough, it’s time for a second look at your budget. Often, after a thorough analysis, you can find more money to put away for retirement. It can be as simple as defining needs versus wants in light of your bigger goals.
Sometimes, the thought of calculating retirement needs and deciding on investments can be overwhelming. Know that there is help. Financial professionals can help provide guidance with your personal situation. (For more from this author, see: The Roth 401(k): Should I Invest in It?)
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