Updated July 2, 2019 . AmFam Team
We all know how important it is to save for retirement. Whether you dream of owning a vacation home or just having time to pursue your passions, it takes a nest egg to retire comfortably. But how much should you save for retirement? And how do you save with a tight income? We have some tips to help you get started.
It might be tempting to put off saving – after all, retirement is ages from now, right? But the earlier you start, the longer you have for your investments to grow. That’s because of compound interest. When you invest in a 401(k), the interest you earn is added to your principal, so your balance grows at an increasing rate. Over the long term, steady investments can add up to a big payout, and help you weather the ups and downs of a volatile stock market.
How much money you need to save depends on you, but a good rule of thumb is 15% of your pre-tax income. Now, that assumes you start saving around age 25 and continue investing steadily until your 67th birthday. The answer also depends on whether you’ll get income from a pension, Social Security, inheritance or other sources.
Here are a couple of examples to illustrate the idea:
Let’s assume you’re 30, and you earn $50,000 per year. You want to retire at age 65. You haven’t saved anything so far. You want to live on 85% of your pre-retirement income in your golden years, which is about $42,500 per year. To reach that goal, you’ll need to save $2 million by the time you retire. That sounds like a lot, right? But remember, that money needs to last you a long time – 30 years or more. At age 30 with nothing in savings, you’ll need to invest $600 per month.
You wait ten years to start saving when you’re 40. Using the same financials, you’ll now need to save $1,000 a month to reach your goal – that’s almost double the amount you’d need to save if you’d started at age 30.
Now let’s see what happens if you start saving for retirement at age 20 and earn $50,000 per year. Using the same assumptions, you’d only need to invest $375 per month. If you saved $1,000 per month starting at age 20, you’d have $8.4 million at retirement. That’s a big difference! It all comes down to compound interest. Starting earlier gives your investments more time to compound, so the interest builds on itself and grows exponentially. When you start later, you have to save more to make up for lost time.
Now that you know how much you need to save, how do you begin? If your employer offers a 401(k) savings plan, take advantage. If not, look into investing in an IRA. These are two different types of investment accounts that offer incentives to save for retirement. Unlike regular investment accounts, they give you tax breaks on your savings, and allow your investments to grow without being taxed.
This employer-sponsored retirement plan makes it easy to save for retirement. Money can be taken out of your paycheck automatically so you don’t even have to think about it. Many employers match a certain amount of contributions (free money!) And, your investment grows tax-deferred, so as long as your money stays in the plan, you don’t owe any taxes.
There are two kinds of IRAs – Roth and traditional. The main difference is how taxes work. In a traditional IRA, the money you contribute may be tax deductible for the year (which means you are investing with pre-tax dollars). You pay income tax on withdrawals in retirement. With a Roth IRA, your contributions aren’t tax-deductible, so you don’t get a break in the short term. But the payoff comes when you retire – withdrawals aren’t taxed at all. Reduce your cost of living
If you’re having trouble finding money to save for retirement, think about how you can cut costs from your everyday expenses. Those café lattes you grab from the coffee shop every day really add up! You could start by making a coffee run once a week, and putting what you would have spent in your retirement account.
Paying down your debts will help set you up for a successful path to retirement. Set a monthly budget and make a plan for paying off loans, credit cards, and other debts. That way, you can put more money into your retirement savings (and not worry about how to pay off accounts when you’re on a fixed income).
This article is for informational purposes only and based on information that is widely available. This information does not, and is not intended to, constitute legal or financial advice. You should contact a professional for advice specific to your situation.