Saving for Retirement 101

Laura Shin
Posted

You Can Save Enough. Here’s How It Works

1. Invest.

We’re going to let you in on a secret: You don’t have to squirrel away the full amount. You only actually put away a fraction of it. But the key is to invest it, rather than putting it in a savings account. There, something magical happens: your money grows. Meaning, $50 saved today could one day turn into more than $1,000.

2. Beat Inflation.

The main reason investing is so important is that inflation will decrease the value of your cash over time. Just like a loaf of bread cost much less when our grandparents were young than it does now, the money you need to buy a loaf of bread today won’t buy you one when you retire. Historically, inflation has increased at a rate of 3% each year. The interest you earn in a savings account is simply not enough to beat inflation for long-term goals like retirement, so the key is to invest your money wisely. The stock market, for instance, has historically yielded an average return of 7%.

3. Start Early.

Time is a key ingredient in the retirement recipe, so the earlier you start planning for retirement, the more money you’ll end up with. For instance, let’s say Jenny and Sarah both invested $24,000 in their retirement funds over the years, but Jenny began putting in money ($50 per month) at age 25 while Sarah began saving ($100 per month) at age 45. Even though they both put in the same total amount, assuming that the market gives them both returns of 7% a year, Jenny will have more than twice as much money for retirement as Sarah will when they turn 65.

How Much You Should Save

You can roughly figure this out with these three questions. (You will use a calculator to actually nail the numbers down, but you should understand how it works.)

Term Sheet

Retirement
n. The time in your life when you transition from working full time to living off of your retirement savings and other income, which in some cases may include pensions or social security.

Inflation
n. A rise in the general price level of goods and services over time that means each dollar buys less as years go by. Historically, inflation has increased at a rate of approximately 3% each year.

1. How much will my lifestyle cost in the future?

Basically, you can use your current monthly living costs to project how much your monthly retirement expenses will be. This kind of calculation takes into account the fact that things like a mortgage might no longer be a part of your budget while other things like health care might actually cost more than they do today.

2. What is my “replacement ratio”?

Your replacement ratio is the percentage of today’s income that you need to replace during retirement. Depending on what replacement ratio you aim for, you can live a range of lifestyles in retirement, such as:

  • Budget Living = 60% replacement of today’s income
    Budget living doesn’t really mean eating cat food at retirement, but it does mean that you might have to be a very cautious spender, with limited resources and little room for extravagance. You could probably rent a one-bedroom apartment and afford hobbies like crafts & volunteering, but you might worry about health care costs and outliving your savings. And that can be stressful as you get older.
  • Comfortable & Content = 70%-80% replacement of today’s income
    In this scenario, you’ve saved enough to keep living at the same level you did before retirement. You probably just paid off your mortgage and any final debt like car loans or credit cards, so now you can afford frequent trips to see grandkids, plenty of social activities, annual vacations and the occasional splurge. If unexpected costs arise, you are prepared with some emergency savings and have a cushion within your nest egg.
  • Luxurious Jetsetter = 100% replacement of today’s income
    You can afford your caviar, a new car if you want it, your winter condo in Florida and your annual trips to Europe. You don’t worry about inflation, increased health care costs, or outliving your savings. You even expect to be able to pass on an inheritance to your kids or family.

3. How much do I need to set aside monthly now to reach that target?

At this point, there’s a bunch of fancy math that determines how much you need to contribute every month from now until retirement to reach your goal.

(To figure out whether you’re on track to meet your retirement goals, compare your current course to the ideal one. A retirement calculator, like this one here, can do this for you.)

What You Should Do Now

1. If you’re not saving for retirement yet, start now.

You would be surprised—if you save 15% of your income every month now, you will likely amass enough money to retire on. Fifteen percent might sound like a big chunk out of your budget, but when you think about it, it’s actually a small contribution toward years and years of work-free living.

2. If you don’t know how much you should be contributing, calculate it!

Try out the retirement calculator linked above. It’s best to know how much you need to be putting away and to make that amount your goal if you can’t contribute that amount today. Use our retirement checklist to get to the contribution amount you need.

3. Start small.

It’s best to start small rather than not start at all. If your goal is to contribute 15% of your salary, start with whatever it takes to get the company match, and more, if you can afford more, and then increase it by 2% every six months until you get to your goal.  Small increases have a tiny impact on your budget and a huge impact on your nest egg. If you feel like you need a guideline to follow, consider these bare minimums:

  • Age 25: Contribute at least 5%
  • Age 30: Contribute at least 10%
  • Age 35: Contribute at least 15%
  • Age 45: Contribute at least 20%

However, the general rule is that the more you can contribute, the better—always!

You can invest in an employer-sponsored 401(k) or 403(b), your own Roth IRA or traditional IRA or other investment vehicles. (Read more about how to do so here.)

Remember …

First, you can do it. Second, you have to start now, even if you start small. And third, always make it a priority, above other kinds of saving.

If you follow these rules, you’ll have a stress-free retirement to look forward to!

  • KimberlyDi

    Luxurious Jetsetter?

    100% of today’s income? I don’t think the most of us have a 100% income that qualifies as a jetsetter. My full income, as many Americans, just pays the bills. I do put 10% away for 401k and nearly the same amount away for personal savings, but Jetsetter I will never be.