When it comes to retiring many people have the same question. How much should I be setting aside for retirement? This is a complicated question because there is not an answer that fits everyone’s situation. In addition, throughout the years a person’s specific situation concerning what they should be setting aside for retirement changes. There are many factors in play when trying to figure out how to save for retirement. Knowing both your short term and long-term savings goals is important. Considering family needs, total availability of resources, and lifestyle is also important when planning for retirement savings. One thing for sure is that people should be saving as much as they can for retirement.
How much do I have to save for retirement?
The answer to how much a person should save for retirement is, as much as possible. As a rule of thumb saving around 10 – 15 percent for retirement is a good target amount. The 10% rate is the least that one should be saving, and 15% rate is the recommended rate if you can afford it. Saving at this rate should ensure that a person can maintain their normal lifestyle in retirement. This amount may vary based on the age at which a person starts saving for retirement and when a person plans to retire. If a person starts saving for retirement no later than their mid-20’s and wants to retire at current retirement age (67), then 15% should be a good rate. If a person begins saving for retirement later, then they may need to save at a higher percentage rate.
Then there are those who are employed and are having their retirement contributions matched. Their 15% portion is partially covered by their employer. For example, a 25-year-old employee who earns a yearly salary of $60,000 would need to save $9,000 towards retirement for the year at a 15% rate. Let’s now consider the same example with the employer matching retirement contributions at 5%. Now the employee would only need to set aside 10% for the year or $6,000 because the employer would contribute the other $3,000 or 5%. The most important thing to mention about employer matches is, MAKE SURE YOU TAKE ADVANTAGE OF IT. If your employer offers a match this is FREE MONEY for your retirement that you must take advantage of. So, whatever you have to do be sure to contribute as much as you can to maximize the value you receive through the employer match. The last thing I will say about the employer match is that it is so important that one should be willing to make great sacrifices to afford greater contributions.
What happens if I start saving too late?
As mentioned before, the recommended rate of 15% is contingent upon when you start saving for retirement. For someone who starts saving for retirement in your early 30’s, that 15% rate will need to be adjusted to more like 18% or 20%, if you still plan on retiring at age 67. The rate of saving continues to increase the longer you wait to start saving. If you wait until your mid 30’s, then you will need to be saving around 23% to 25%. So of course, it is better to start saving early because the sooner you start saving, the less income you must put back for retirement over the years.
The rate that one chooses to save is not just dependent on when they start saving, but also depends on when they want to retire. If someone wants to retire sooner than age 67 then they should try to begin as early as possible. They will want to save at a higher rate. On the other hand, many people are deciding to work past the age of retirement whether it be from necessity or just boredom. You may need to do this if you want or need to save for retirement at a lower rate.
Other forms of retirement income
Having other forms of retirement income also plays a role in how much a person should save for retirement. Many people receive income from sources like pensions, rentals, royalties, annuities, inheritance, and social security after retirement. These variable sources of income are hard to build a solid plan around. People usually do not know how much income these sources will produce as they contribute to their retirement throughout the years. The good thing is that if you have these post retirement sources of income, they will assist on financing your lifestyle in your later years.
When considering the rate at which you will save, you must also consider the contribution limitation for various retirement accounts. 401k contributions made by the employee are limited currently in the year 2020 to $19,500. If you are age 50 or above you have the option of contributing an additional $6,500. So, for someone under the age of 50 who is earning $100,000 per year, they would not be able to contribute more than 19.5% to their 401k for the year unless their employer did a match. If that person wanted to save more than 19.5% then they would need to contribute to another form of retirement account like a Traditional or Roth IRA. Fore more insight on the differences of a 401K and IRA you can check out our blog post here. Though the IRA accounts are good options, these accounts also have limits. Both Traditional and Roth IRA’s are limited to contributions of $6,000 with the option of contributing an additional $1,000 if you are age 50 or more for the year 2020.
Need additional assistance in figuring out your retirement options?
As you can see there is no cookie cutter answer to this question. My advice would be to take into consideration your income, normal expenses, and lifestyle. Then I would try to come up with a ration of how you will split up the amount of your income to save for retirement vs spend on anything else (i.e. 85/15…spend vs save).
As usual Molen & Associates is here to discuss your concerns and advise accordingly on this topic. We offer family finance consultations and wealth management services. If you need us to help you create a budget for retirement savings, but also aide you on the investing side give us a call and we’d be happy to serve you.
Arthur Harrison, III
Tax Advisor, Accounting, EA