How much should I save for retirement?

Retirement might seem like it’s very far away, especially if you’re in your 20s or 30s. But while it’s tempting to delay saving, this is one area where you don’t want to procrastinate. In fact, according to AARP, nearly half of American retirees cite running out of money as their chief concern.

Starting early gives you more time to save, and it gives your investments more time to potentially grow. Thanks to the power of compounding returns, that might mean you don’t have to save as aggressively when you’re older. (After all, it’s no fun playing catchup.)

Saving for retirement is like preparing for a road trip…

Oftentimes when a person goes on a road trip, it’s hard to anticipate every cost. Maybe the RV’s engine overheats, or the plumbing breaks down. Along the way, you might have to stop at a mechanic. While you might have a general sense of where you want to go and how much your trip might cost, you can’t perfectly prepare for everything.

Retirement can be similar. To achieve the lifestyle you want, you’ll need to make sure you have enough saved to cover not just your necessities, but also all the other activities and purchases that matter to you. Nobody wants to run out of money, on the road or in retirement. So, let’s take a closer look at how you can start to prepare.

There are two main types of retirement accounts: workplace plans, such as the 401(k) and 403(b), and IRAs. Both offer a tax benefit to help incentivize saving. It’s important to note you can’t withdraw the funds in these accounts before retirement age (generally considered 59½), without paying a 10% early withdrawal penalty, plus any income tax due.

401(k)s

401(k) plans are retirement accounts typically offered to employees by their employers. Essentially, every time you receive a paycheck, you take part of the money and put it away for later (We’ll get to the details in a second). For people under the age of 50, the Internal Revenue Service (IRS) allows you to sock away up to $20,500 in a 401(k) every year as of 2022. For people over 50, that limit increases to $27,000. (This can be especially helpful for people who haven’t saved much earlier on.) In 2023, the contribution limit is $22,500 for those under 50 and $30,000 for those 50 and over.

There are several types of 401(k) plans, and each one works a bit differently. We’ll talk about two of the most common types: Traditional 401(k)s and Roth 401(k)s. The main difference between them is when taxes are incurred.

With a Traditional 401(k), you get a tax deduction today, so your taxes are deferred. When you contribute to a traditional 401(k), money from your paycheck goes into your retirement account tax-deferred — this means that you get a tax deduction on your income for that year. For example, if you earned $60,000 this year and you contributed $5,000 of your earnings to a traditional 401(k), you would pay taxes on just $55,000 in 2022. Your taxes don’t just disappear though. While you get a tax break up front, when you withdraw money from the account in retirement, you’ll pay taxes on the withdrawal, based on your future tax bracket.

If you anticipate being in a lower tax bracket when you retire, a traditional 401(k) might be a good way to think about minimizing your total taxes. The idea is that your future tax rate might be lower than the rate you’d pay when you saved this money in the first place.

With a Roth 401(k), you pay taxes today, so you get a tax break later. When you contribute to a Roth 401(k), you don’t get a tax break today. Even though you’re saving for retirement, you pay taxes as if all that money is going into your pocket right away. But here’s the benefit — any income you earn in the account, dividends, interest, and capital gains, belong to you entirely, because it can grow tax free (subject to limitations). Of course, you have to weigh whether this strategy makes sense for you — It means paying more taxes sooner, and nobody can say exactly how taxes will shake out in 30 or 40 years.

In addition to their tax benefits, one of the most important features of a 401(k) is the possibility of an employer-sponsored matching incentive (aka “an employer match”). It’s kind of like getting sponsored by friends and family to run in a marathon (e.g., $1 for every mile you run).

Here’s how it works: Many companies offer a 401(k) match, for instance, matching 3% of your annual salary if you contribute to your retirement account. If you earn $60,000 per year and you contribute 3%, that means you would save $1,800 yourself and your company would kick in another $1,800 on your behalf. (Pretty great, right?)

That’s not always the case though. How the employer match works—and whether it exists at all—varies. Some companies may only offer 50% of your contribution amount. So, if you saved $1,800, they might put up $900. (Still, not too shabby.) Just know, there might be other limitations. For example, you might have to stay with the company for a certain number of years to keep their contributions (you might ask your plan’s administrator about your “vesting schedule”). There’s also a chance that an employer might discontinue its match. Regardless, if your job offers this benefit, it’s probably a good idea to save in your 401(k), at least contributing enough to get the full match. If you don’t, you’re basically leaving money on the table.

Usually your employer chooses the plan administrator for the account. However, if you leave a job, you’re free to roll this money over into a retirement account that you choose, or one that’s associated with your new employer.

IRAs

IRAs are individual retirement accounts and they’re totally separate from your employer. You can open an IRA at many financial institutions. Like 401(k)s, IRAs come in a few varieties. Some of the most common types are Roth IRAsand Traditional IRAs. (There are also SEP IRAs, Simple IRAs, and a few more.) The main difference between the Traditional and Roth IRA is when you pay taxes on the money in the account.

For 2022, the IRS total contribution limit for traditional and Roth IRAs is $6,000 per year for those under the age of 50. For people 50 and over, the contribution limit is $7,000. Typically, these limits increase year after year to help keep pace with inflation: in 2023, you'll be able to contribute $6,500 (or $7,500 if you're 50 or older).

Traditional IRA

As with a traditional 401(k), money can go into a traditional IRA tax-deferred and may grant you a tax deduction, depending on your income. When that money is withdrawn in retirement, you pay income taxes on all of it. While anyone with earned income can contribute to a traditional IRA, whether or not you can take a tax deduction depends on the amount of income you earn and whether or not you and your spouse are covered by a workplace retirement plan.

Roth IRA

Likewise, a Roth IRA parallels a Roth 401(k). In a Roth IRA, contributions are taxed at the time they enter the account. But when you withdraw your funds in retirement, they (and any gains) are tax-free if relevant conditions are met.

For anybody wondering, they’re called “Roth” IRAs and Roth 401(k)s because the associated legislation for these retirement accounts was introduced by Senator William Roth back in 1997.

Other Taxes and Penalties

While retirement accounts can offer useful tax benefits, you must check whether their provisions make sense for your situation. That’s because these accounts often have some important restrictions. Here’s a major one: You can’t freely withdraw the funds before retirement age (generally, the age of 59½ ). Doing so typically incurs an early withdrawal penalty of 10% in addition to any applicable income taxes.

Conventional wisdom suggests saving for at least 30 years of retirement, or potentially longer. Life expectancy continues to rise with developments in the medical field, so you may end up needing more than that. Despite these unknowns, the first step in deciding how much to save is to consider what kind of life you’d like to live during these years.

Where do you want to live?

Just like planning a vacation, you probably should think about where you want to go. Are you going to sip lemonade on the beach in Florida? (A state with no personal income tax.) Or do you see yourself living in a Manhattan high-rise, clubbing well into your 80s?

But before you imagine life as a breakdancing octogenarian, you might think about what else you’ll need—and what you can afford. Do you want to stay close to family and friends? What type of medical care could you need? Depending on your financial situation, you might want to stay in a home where you’ve paid off the mortgage. Ultimately, whatever your lifestyle, your expected cost of living can help inform your savings goals.

What do you want to do?

If your bucket list includes traveling the world or building a house, you’ll need to save more to account for these plans. Consider also how you might like to help your family. Would you pay for your grandchildren’s college expenses? Treat the kids to a trip to Disney World? Do you care about donating to charity, or leaving behind an inheritance?

When do you hope to stop working?

In the US, many people expect to retire around age 66, according to a 2018 Gallup Survey. (Note: This is higher than it was in the 1990s, due to eroding confidence in social safety nets like pensions and social security, and a rising cost of living.) A host of things factor into when you want to retire, not least of all whether you just want to continue working.

These life choices matter because they affect how much you might withdraw, or need to withdraw, from your retirement account(s) every year. You should also plan for unexpected costs, like medical care, which may grow as you get older.

It depends a lot on how much you might spend. The American Association of Retired Persons (AARP) says retirees might expect to spend 70% to 80% of their pre-retirement annual income per year. If a person earned $100,000 before they retired, that means they might aim to spend around $75,000 per year. That might not be enough though. Some financial planners recommend planning to spend as much as 75 to 85 percent of your annual income every year in retirement. Retirement calculators can help visualize how much you might be able to save over a specific period of time, at different potential rates of return.

Some financial planners have recommended “the 4 percent rule” to guide your retirement savings. By this estimate, you would withdraw four percent of your savings from your retirement fund every year.

If you think about this backwards, you can try to forecast how much you’ll need in retirement. By multiplying your annual spending by 25, you can calculate how much you might want to target. For instance, a person who spends $40,000 per year now would need $1 million for a retirement lifestyle that’s in line with the lifestyle from their working days.

For some people, this estimate could be too low, because when the concept first emerged, it assumed greater support from public systems like social security, and higher interest rates. Still, the principle holds up to some degree. If you can earn more on your investments than you spend each year, that’s a great starting point. However you proceed though, you shouldn’t rely on one calculator or formula to plan your retirement. It’s ideal to start saving as early as you can, as you may have only 30 or 40 years to save, and may need $1 million (or more) for a comfortable retirement.

1. If you’re not saving for retirement yet, start as soon as you can. Having a retirement savings plan early will lessen the burden of saving as you get closer to retirement age. At a minimum, aim to take full advantage of your employer match on a 401(k), if your employer offers one — It’s free money.
2. Work your way up to saving 12 to 15 percent, or more, of your income in retirement savings accounts. If you’re just getting started and you can’t afford to save much, you might try setting a goal of increasing your savings by 1%each year.
3. Pay off debt, especially high-interest debt, so you’ll have more opportunities to invest your savings rather than pay interest on accumulating debt.
4. Take time to learn how your retirement savings are invested and understand any fees involved. As a general rule, the closer you grow to retirement, the more you should shift your retirement investments from relatively riskier assets with higher returns (stocks) to lower risk assets like US government bonds.

Social security is a government program that provides monetary assistance to citizens of a certain age. For retirees in the US, the Social Security Administration pays a monthly sum that is a portion of your pre-retirement wages (once you’ve worked a set amount of years). On average, however, Social Security recipients obtain just 40% of their pre-retirement wages, so it’s important not to depend on Social Security to fund your retirement. There are tough questions about how the program will look in the next 20 to 40 years, and whether it will even exist, especially as the US national deficit continues to grow. So, while it’s good to know the program exists right now, it’s best not to depend on it.

Some people want to retire much sooner than the traditional age. The FIRE movement advocates for extreme saving, encouraging people to sock away 70% or more of their income during their working years. They believe This might allow them to retire early and live off that pot of savings. FIRE” stands for “Financial independence, retire early.”

Born from Joe Dominguez and Vicki Robin's book Your Money or Your Life, published in 1992, the FIRE movement has been particularly appealing to those between the ages of 20 to 40. But there can be significant risks to this plan. First, savings are subject to events in the wider world, including the ups and downs of the stock market and changes to interest rates. Unforeseen circumstances can wreck even the best laid plans, hampering your ability to live the life you want in retirement (or to even stay retired). The extreme frugality required to save 70% of your paycheck might also mean foregoing many simple pleasures in life.

In all, there’s no one number or percentage that can dictate how much to save for retirement. Just like planning a road trip, the scope of your retirement fund is a personal decision, influenced by your lifestyle choices as well as a host of factors you can’t control, like interest rates and the stock market. The best thing you can do is start early, or as soon as you can. To strive for success, it’s helpful to reflect on what you want in the future, find ways to start saving, and continue to build your plan from there.

Funds being contributed into or distributed from retirement accounts may entail tax consequences. Contributions are limited and withdrawals before age 59 1/2 may be subject to a penalty tax. Robinhood does not provide tax advice.