Retirement is a stage of life that many people look forward to, but it also requires careful planning and preparation. Saving for retirement can seem daunting, especially if you don’t know where to start or how much you need. However, with some simple steps and strategies, you can build a retirement nest egg that can support your lifestyle and goals in your golden years. Here are some tips on how to save for retirement.
1. Set Your Retirement Savings Goal
The first step to saving for retirement is to have a clear idea of how much money you will need to live comfortably and pursue your interests. There are different ways to estimate your retirement savings goal, but one common method is to use the 25x rule. This rule suggests that you multiply your expected annual expenses in retirement by 25 to get the total amount you need to save¹. For example, if you think you will spend $50,000 per year in retirement, you will need to save $1.25 million.
The 25x rule is based on the assumption that you will withdraw 4% of your portfolio in the first year of retirement, and then adjust that amount for inflation in the following years. This is known as the 4% rule, and it is designed to make your savings last for 30 years¹. However, the 4% rule may not work for everyone, depending on factors such as your life expectancy, investment returns, and spending patterns. You may want to use a more conservative withdrawal rate, such as 3% or 3.5%, to account for these uncertainties.
Another way to set your retirement savings goal is to use a retirement calculator, such as the one offered by NerdWallet⁵. This tool can help you estimate how much you need to save based on your age, income, current savings, desired retirement age, and expected retirement income sources. You can also adjust the variables to see how different scenarios affect your retirement outcome.
2. Contribute to a Retirement Savings Account
The best way to save for retirement is to use a retirement savings account, such as an individual retirement account (IRA) or a 401(k) plan. These accounts offer tax advantages that can help your money grow faster and reduce your tax burden in retirement. There are two main types of retirement savings accounts: traditional and Roth.
Traditional Accounts
Traditional accounts, such as traditional IRAs and 401(k)s, allow you to make pre-tax contributions, meaning that you can deduct the amount you contribute from your taxable income in the year you make the contribution. This can lower your tax bill in the present and defer taxes until you withdraw the money in retirement. However, when you withdraw the money, you will have to pay income tax on both the contributions and the earnings.
The annual contribution limit for traditional IRAs in 2023 is $6,500 ($7,500 if you are 50 or older), and the limit for 401(k)s is $20,500 ($27,000 if you are 50 or older)¹. If you have access to a 401(k) plan through your employer, you may also benefit from an employer match, which is when your employer contributes a certain percentage of your salary to your account, up to a limit. This is essentially free money that can boost your retirement savings.
Roth Accounts
Roth accounts, such as Roth IRAs and Roth 401(k)s, allow you to make after-tax contributions, meaning that you pay taxes on the money you contribute in the year you make the contribution. This means that you will not get a tax deduction in the present, but you will enjoy tax-free withdrawals in retirement. This can be advantageous if you expect to be in a higher tax bracket in retirement than you are now.
The annual contribution limit for Roth IRAs in 2023 is the same as for traditional IRAs: $6,500 ($7,500 if you are 50 or older). However, not everyone is eligible to contribute to a Roth IRA, as there are income limits that phase out the ability to contribute. For 2023, the phase-out range is $129,000 to $144,000 for single filers and $206,000 to $221,000 for married couples filing jointly¹. The annual contribution limit for Roth 401(k)s is the same as for traditional 401(k)s: $20,500 ($27,000 if you are 50 or older). There are no income limits for contributing to a Roth 401(k).
3. Choose Your Investments Wisely
Once you have decided which type of retirement savings account to use, you need to choose how to invest your money within the account. The main factors to consider are your risk tolerance, your time horizon, and your asset allocation.
Risk Tolerance
Your risk tolerance is how much risk you are willing to take with your investments, and how well you can handle the ups and downs of the market. Generally, the higher the risk, the higher the potential return, but also the higher the chance of losing money. You need to find a balance between risk and return that suits your personality and goals.
A common way to measure your risk tolerance is to use a questionnaire, such as the one offered by Vanguard. This tool can help you determine your risk profile, which ranges from conservative to aggressive, and suggest an appropriate portfolio mix based on your answers.
Time Horizon
Your time horizon is how long you plan to keep your money invested before you need to use it. Generally, the longer your time horizon, the more risk you can afford to take, as you have more time to recover from market downturns and benefit from compounding returns. As you get closer to your retirement date, you may want to reduce your risk level and shift your portfolio to more conservative investments, such as bonds and cash.
A common way to adjust your portfolio based on your time horizon is to use a target-date fund, which is a type of mutual fund that automatically adjusts its asset allocation according to a predetermined retirement date. For example, if you plan to retire in 2050, you can choose a target-date fund with 2050 in its name, and the fund will gradually reduce its exposure to stocks and increase its exposure to bonds and cash as you approach 2050. This can simplify your investment decisions and help you stay on track with your retirement plan.
Asset Allocation
Your asset allocation is how you divide your portfolio among different types of investments, such as stocks, bonds, and cash. Your asset allocation is the main determinant of your portfolio’s risk and return, and it should reflect your risk tolerance and time horizon.
A common way to choose your asset allocation is to use a rule of thumb, such as the 110 minus your age rule. This rule suggests that you subtract your age from 110 and use the result as the percentage of your portfolio that should be invested in stocks. For example, if you are 40 years old, you should invest 70% of your portfolio in stocks (110 – 40 = 70) and the remaining 30% in bonds and cash. This rule is based on the assumption that stocks are more risky but offer higher returns than bonds and cash, and that you should reduce your risk level as you age.
However, this rule is not a one-size-fits-all solution, and you may want to adjust it according to your personal circumstances and preferences. For example, if you have a higher risk tolerance or a longer time horizon, you may want to invest more in stocks than the rule suggests. Conversely, if you have a lower risk tolerance or a shorter time horizon, you may want to invest less in stocks than the rule suggests.
4. Save Early and Often
The key to saving for retirement is to start as soon as possible and save as much as you can. The earlier you start saving, the more time your money has to grow and compound, and the less you have to save each month to reach your goal. Conversely, the later you start saving, the less time your money has to grow and compound, and the more you have to save each month to reach your goal.
To illustrate this point, let’s compare two hypothetical savers: Alice and Bob. Alice starts saving for retirement at age 25, and she contributes $500 per month to a retirement account that earns an average annual return of 7%. By age 65, she will have accumulated $1.2 million. Bob starts saving for retirement at age 35, and he contributes the same amount of $500 per month to the same account that earns the same return of 7%. By age 65, he will have accumulated $567,000. As you can see, Alice ends up with more than twice as much money as Bob, even though they both saved the same amount of money per month. The difference is that Alice started saving 10 years earlier than Bob, and she benefited from the power of compounding.
The lesson here is that saving for retirement is not only about how much you save, but also about when you start saving. The sooner you start saving, the easier it will be to reach your retirement goal. If you haven’t started saving yet, don’t worry. It’s never too late to start, and any amount of savings is better than none. The important thing is to start saving now and make it a habit.
5. Increase Your Savings Rate
Another way to boost your retirement savings is to increase your savings rate, which is the percentage of your income that you save for retirement. The higher your savings rate, the faster you can grow your nest egg and the sooner you can retire. However, increasing your savings rate may require some trade-offs, such as cutting your expenses, increasing your income, or both.
One way to cut your expenses is to create and follow a budget, which can help you track your income and spending, identify areas where you can save money, and set realistic and achievable goals. You can use a spreadsheet, an app, or a website to create and manage your budget. Some examples of budgeting tools are Mint, YNAB, and EveryDollar .
Another way to cut your expenses is to adopt a frugal lifestyle, which means living below your means and avoiding unnecessary spending. You can save money by reducing or eliminating some of the following expenses:
- Eating out and ordering food: You can cook your own meals at home, plan your menus ahead, use coupons and discounts, and buy in bulk.
- Entertainment and hobbies: You can find free or low-cost activities, such as reading, hiking, playing games, or watching movies online. You can also borrow or swap books, music, and movies with your friends or family, or use your local library.
- Transportation: You can walk, bike, carpool, or use public transportation instead of driving your own car. You can also save money on gas, maintenance, and insurance by driving less, driving a fuel-efficient car, or selling your car altogether.
- Housing: You can save money on rent or mortgage by living in a smaller, cheaper, or shared space, or by moving to a lower-cost area. You can also save money on utilities by using less water, electricity, and heating, or by switching to renewable energy sources.
- Shopping: You can save money by buying only what you need, not what you want, and by comparing prices and quality before you buy. You can also save money by buying second-hand, repairing, or repurposing items, or by selling or donating what you don’t need.
Another way to increase your savings rate is to increase your income, which can give you more money to save and invest. You can increase your income by doing some of the following things:
- Asking for a raise or a promotion: You can negotiate a higher salary or a better position with your current employer, based on your skills, performance, and value. You can also look for other job opportunities that offer higher pay or better benefits.
- Working more hours or taking on a side hustle: You can earn extra money by working overtime, taking on additional projects, or finding a part-time or freelance job that suits your schedule and interests. You can also use your skills, hobbies, or passions to create a product or service that you can sell online or offline.
- Investing in yourself: You can improve your skills, knowledge, and credentials by taking courses, attending workshops, reading books, or getting certifications. This can help you advance your career, increase your earning potential, and open up new opportunities.
- Creating passive income streams: You can earn money without active involvement by creating passive income streams, such as dividends, interest, royalties, rent, or online sales. You can also use your retirement savings account to generate passive income by investing in income-producing assets, such as stocks, bonds, or real estate investment trusts (REITs).
6. Review and Adjust Your Plan Regularly
The final step to saving for retirement is to review and adjust your plan regularly, at least once a year or whenever you experience a major life change, such as getting married, having a child, changing jobs, or retiring. Reviewing and adjusting your plan can help you stay on track with your retirement goal, monitor your progress, and cope with any challenges or opportunities that arise.
Some of the things you should review and adjust are:
- Your retirement savings goal: You may want to revise your retirement savings goal based on your current and expected expenses, income, and lifestyle in retirement. You may also want to account for inflation, taxes, health care costs, and other factors that may affect your retirement income and spending.
- Your savings rate: You may want to increase your savings rate if you are behind on your retirement goal, or if you want to retire earlier or more comfortably. You may also want to decrease your savings rate if you are ahead of your retirement goal, or if you need more money for other financial priorities, such as paying off debt, buying a home, or saving for education.
- Your investments: You may want to rebalance your portfolio to maintain your desired asset allocation and risk level, or to take advantage of market conditions and opportunities. You may also want to diversify your portfolio to reduce your exposure to specific risks, such as market volatility, currency fluctuations, or political instability.
- Your withdrawal strategy: You may want to plan how you will withdraw your money from your retirement savings account, such as when, how much, and from which account. You may also want to consider the tax implications, fees, and penalties of your withdrawals, and how they will affect your retirement income and spending.
Saving for retirement may seem complicated, but it doesn’t have to be. By following these six steps, you can create and execute a retirement plan that works for you and your goals. Remember, the sooner you start saving, the better off you will be in retirement. Happy saving!
