Retirement is a goal that many people aspire to, but it also requires careful planning and preparation. Saving for retirement can seem challenging, especially if you don’t know when 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 what is the best age to start saving for retirement.
The Sooner, the Better
The answer to the question of what is the best age to start saving for retirement is simple: as soon as you can. Ideally, you’d start saving in your 20s, when you first leave school and begin earning paychecks³. That’s because the sooner you begin saving, the more time your money has to grow and compound, and the less 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.
How Much to Save
The next question to ask is how much you need to save for retirement. This depends on several factors, such as your expected retirement age, your desired retirement income, your current savings, your investment returns, and your sources of retirement income, such as Social Security, pensions, or annuities.
One common way to estimate how much you need to save for retirement 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 estimate how much you need to save for retirement is to use a retirement calculator, such as the one offered by NerdWallet. 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.
Where to Save
Once you have an idea of how much you need to save for retirement, you need to decide where to save your money. The best place to save for retirement is 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).
When to Retire
The final question to ask is when you want to retire. This depends on your personal preferences, your financial situation, and your health status. Some people may want to retire as early as possible, while others may want to work as long as they can. There is no right or wrong answer, but there are some factors to consider.
One factor is your Social Security benefits, which can be claimed as early as 62, but with your benefits reduced by 25%-30%. Depending on the year you were born, postponing taking Social Security until age 66 or 67 will allow you to receive full benefits². You can also boost your monthly Social Security payments if you delay claiming until age 70².
Another factor is your health insurance, which can be a major expense in retirement. Retirees at the age of 65 qualify for Medicare benefits, but if you retire before that, you will have to find another source of health coverage, such as your spouse’s employer, your former employer, or the health insurance marketplace². This can be costly and complicated, so you may want to wait until you are eligible for Medicare before retiring.
A third factor is your lifestyle, which can affect your retirement income and spending. Some people may want to retire early and pursue their hobbies, travel, or volunteer, while others may enjoy working and staying active. Some people may have a lower cost of living in retirement, while others may have higher expenses. You need to consider what kind of retirement you want and how much it will cost you.
Conclusion
Saving for retirement is a smart and important goal, but it can also be confusing and overwhelming. The best age to start saving for retirement is as soon as you can, and the best way to save is to use a retirement savings account that suits your tax situation. The best age to retire is up to you, but you need to consider your Social Security benefits, your health insurance, and your lifestyle. By following these tips, 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!