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How Much Should You Save For Retirement?

How Much Should You Save For Retirement?

December 13, 2021
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We often hear people say "You should save 15% of your earnings towards retirement". This sounds like a lot, but is it enough? Today's topic is the power of compound interest when saving for retirement. Retirement savings are a crucial element in the retirement planning process, and they are often something that aren't started early enough. When it comes to investing, especially pertaining to long term retirement investments, time can sometimes be more important than the amount saved. For example, imagine you were to start saving $200 per month starting at age 45 for 20 years until retirement at age 65. If you were to earn an average rate of return of 6% per year, your total account value at age 65 would be $88,285.42. Now instead, let's say you saved half as much money, saving only $100 per month, but started at age 35, allowing you to save for 30 years. That same 6% rate of return would come out to $94,869.82. You saved half as much on a monthly basis, but started 50% earlier, and ended up with $6,584.40 more in your retirement savings. This is one reason why having a retirement savings plan is important for everyone, and the earlier you start the better.

We know that starting early is important, and we know we should be saving, but how much is appropriate for you? This amount will be different for every individual, and is another reason why having a retirement plan is important. You may have a pension plan from your employer or a 401k with an employer match. If you do, that can make a big difference to the overall amount you would need to be saving individually towards your retirement. We recommend you speak with your financial professional about what amount is appropriate for you based on your retirement plan. Lets look at a three different scenarios below.

For each scenario we will imagine John (35), Walter (35), and Sam (25) all want to retire at age 65. All three have income of $48,000 per year, and all 3 will have an estimated social security benefit of $1,250 per month at age 65. We will also assume that each individual will earn 3.5% in income from their retirement savings once in retirement.

*John - John is 35 and has a defined benefit pension plan from his state government employer plan. John also will start saving $200 per month earning an average of 6% interest per year until retirement.

Account values at retirement:  

Pension plan: 40% of income annually, or $19,200 annually ($1,600 per month).

Savings: $189,739.65 x 0.035% = Annual income of $6,640.89 ($553.40 per month)

Social Security: $1,250 per month 

Total: $1,600 + $553.40 + $1,250 = $3,403.40 per month in retirement income. John's total out of pocket pre-tax savings = 5%.

*Walter - Walter is also 35 and has a 401k plan from his private employer. Walter's employer contributes 5% to his 401k annually (his company's max) and Walter contributes 5%. Walter also will start saving 400$ per month earning an average of 6% interest per year until retirement.

Account values at retirement: 

401k: $379,479.29 x 0.035% = Annual income of $13,281.77 ($1,106.81 per month)

Savings: $379,479.29 x 0.035% = Annual income of $13,281.77 ($1,106.81 per month)

Social Security: $1,250 per month

Total: $1,106.81 + $1,106.81 + $1,250 = $3,463.62 per month in retirement income. Walter's total out of pocket pre-tax savings = 15%.

*Sam - Sam is younger then John and Walter and is 25 and has a 401k plan from his private employer like Walter. Sam's employer contributes 5% to his 401k annually (his company's max) and Sam also contributes 5%. Sam also will start saving $100 per month earning an average of 6% interest per year until retirement.

Account values at retirement: 

401k: $742,857.43 x 0.035% = Annual income of $26,000.01 ($2,166.67 per month)

Savings: $185,714.36 x 0.035% = Annual income of $6,500 ($541.66)

Social Security: $1,250 per month

Total: $2,166.67 + $541.66 + $1,250 = $3,958.33 per month in retirement income. Sam's total out of pocket pre-tax savings = 7.5%.

Results:

John - Monthly income in retirement: $3,403.04, he saves 5% of his pre-tax income per year.

Walter - Monthly income in retirement: $3,463.62, he saves 15% of his pre-tax income per year.

Sam - Monthly income in retirement: $3,958.33, he saves 7.5% of his pre-tax income per year.

As we can see, it's not about how much you save, but how you save, for how long you save, and how your other retirement assets will tie in to your overall retirement income in the future. To help determine how much you should be saving towards your own retirement plan, schedule a meeting with one of our qualified financial professionals today!

*This hypothetical example is for illustrative purposes only, and its results are not representative of any specific investment or mix of investments. Actual results will vary