How to Save for Retirement

You know that saving for retirement is important, but it’s hard to know where to start.

If you're just starting to save, or maybe you’ve avoided it because it can be confusing, you’re in the right place! Saving for retirement doesn’t have to be complicated, and you can actually get started right now.

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Determine Your Retirement Goal

The best place to start when planning for any goal is to evaluate your end target. If retirement is your destination, you need to figure out what it'll take to get there before creating a financial roadmap to reach that goal.

To reverse engineer your retirement, you’ll want to create a clear picture of what it could look like. Ask yourself these questions:

• Where will I live?
• Will I own my home, and will I have a mortgage?
• How much do I want to travel?
• What will my monthly expenses look like?
• Are there any large, one-time expenses I anticipate, like buying an RV, a boat, etc?

Knowing what you want your retirement to look like gives you an idea of how to proactively plan for it.

How much you need for retirement

The general consensus among financial professionals is that once you retire, you can safely withdraw 4% of your savings per year.

To do that, you should save around 25 times your annual spending to avoid running out of money.

Here’s how the math breaks down:

• If you spend $50,000 per year in retirement, you need $1.25 million invested to retire.
• If you spend $60,000 per year in retirement, you need $1.5 million invested to retire.
• If you spend $100,000 per year in retirement, you need $2.5 million invested to retire.

If saving enough to take advantage of the 4% rule is out of the question, use Erika's free investment calculator to determine what's feasible.

Related: How Much Do I Need to Retire?

Begin to Invest Every Month

The best investors invest a set amount every month, letting their money grow over time with the power of compound interest.

To figure out how much you can invest, you’ll need to create a budget. Once you know your regular expenses, you can calculate how much you have to put toward retirement.

And it may be less than you think! Even a few hundred dollars can add up.

For example, if you are 25 years old and invest $500 per month at an 8% return, your investments can grow to $1.7 million by the time you’re 65 years old.

Use Erika's calculator and play with the numbers to figure out how much you need to invest to hit your retirement goals.

Related: How To Start Investing

Open Retirement Accounts

Retirement accounts are investment accounts that help you save on taxes while saving for retirement. There are limitations to each type of account, and different tax strategies to choose from.

401(k)

A 401(k) plan is an employer-sponsored retirement account, typically available from your day job. Not all companies provide access to a 401(k), but many do.

Many also offer a “company match,” which means the company will put extra funds into your account based on how much you contribute.

For example, your company may offer a 50% match up to 6% of your salary, which means for every dollar you invest up to 6% of your gross pay, your company will invest $0.50. This is an instant 50% return on investment!

Each 401(k) plan usually has a custodian that handles the investments (such as Fidelity), and there is generally a preset selection of investments to choose from.

There are two types of 401(k)s:

• Traditional 401(k): You contribute pre-tax money and it grows tax-deferred. This means you get a tax break today, but you'll pay income taxes when you withdraw it in retirement.
• Roth 401(k): You contribute money that's been taxed, so the withdrawals (including gains) will be tax-free. However, employer contributions are put in a separate bucket and considered pre-tax income. Those contributions and their growth will be taxed as income.

Note that you cannot withdraw from a 401(k) account until age 59.5 (outside of a few exceptions), so make sure to account for that in your retirement plans.

Related: How To Find Your Old 401(k)

IRA

An individual retirement account (IRA) is another type of tax-advantaged retirement account.

The big difference between an IRA and a 401(k) is that you get to choose the company to invest with and have a much wider selection of investments to choose from.

You must have earned income to contribute to an IRA.

There are two types of IRAs: the traditional IRA and the Roth IRA.

• Roth IRA: You contribute post-tax dollars, and can withdraw it tax-free in retirement. If you anticipate higher taxes in retirement than when you’re working, this can help you save.
• Traditional IRA: This is tax-deductible in the year you contribute, and you'll pay tax on it in retirement. If your income tax rate is high right now, a traditional IRA can help you save more money in taxes upfront.

Related: IRA vs. 401(k): Which One Is Better for You?

Choose Your Investments

Now that you know the common types of retirement accounts, you will have to choose your investments inside of those accounts.

There are thousands to choose from, but don't get bogged down in the details. A simple, diversified investment strategy beats most professional investors over the long term.

Common index funds

Index funds are a portfolio of stocks or other assets bundled into a single fund that tracks the performance of a given market index.

For example, the Standard & Poor's 500 (S&P 500) is a popular stock market index that tracks the performance of the top 500 companies in the U.S. If you buy an S&P 500 index fund, you own a piece of each of those companies.

Index funds are typically low-cost and you can invest directly through your preferred broker (such as Vanguard or Fidelity), or purchase shares of index fund ETFs through investing apps like M1 Finance or Webull.

Target date funds

Target date funds are a passively managed portfolio of index funds and other assets that automatically rebalance as you get older.

These funds are designed to be more aggressive in their investments when you’re younger (and can take more risk), and get more conservative as you get closer to retirement.

Target date funds are named for the anticipated year of retirement. You invest in a target date fund based on when you think you’ll retire, and the fund’s asset allocation is tailored to that date.

For example, Vanguard’s Target Retirement 2060 fund anticipates a retirement date of 2060, so the fund will be more aggressive now, and become more conservative as it gets closer to the year 2060.

Bonds

Bonds are corporate or government-backed debt that is funded by investors. When you buy a bond, you are buying a loan that will pay you back (with interest) over time.

You can also buy bond index funds that hold a mix of thousands of different types of bonds with differing maturity dates. This allows you to diversify your bond holdings.

Bonds are seen as a “safer” investment than the stock market, but they don’t generate as high returns. And bonds are subject to risks as well, such as increasing interest rates, which can hurt their long-term performance.

Set Up Automatic Investments

Once you’ve chosen your investment accounts and the types of investments you want to invest in, it’s time to commit to your plan.

You can set up recurring investments that contribute to your retirement accounts without you having to lift a finger.

For your 401(k) or other workplace account, contact your HR department and let them know you want to contribute. Choose what percentage (or dollar amount) you can contribute each month, and you will be enrolled in the plan. Your contributions will come out of each paycheck automatically. 

For IRA accounts, you can set up automatic investments in your account dashboard. Most IRA companies allow you to set up recurring deposits on a weekly, bi-weekly, or monthly basis, and will automatically invest them into your chosen investments.

Increase Your Contributions Over Time

You can always increase your contributions to speed up your path to financial independence.

If you get a raise at work or a new job with a pay bump, commit to contributing some of that new income toward retirement. If you can increase your contributions by just 1% per year, you’ll grow your retirement accounts at an exponential rate.

Related: How Much Can I Afford to Invest?

FAQs

Is saving $1,000 a month good for retirement?

Yes, it's amazing! Most people are not saving this much and you're doing great if you contribute that much per month.

I think the real question to ask is, “Is it enough?” and that really depends on what your retirement goals are and how long you have to save.

What about the rule of thumb to save 15% of your income for retirement?

There are several rules of thumb about what percentage of your income you should save for retirement. Whether or not they will fit your needs depends on how much you want to have saved and your current age.

If you are younger, 15% might be perfect. If you are getting closer to retirement, 15% probably isn't enough to meet your goals.

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