Am I Saving Enough Money For Retirement and How Much You Should Be Putting Away in 401K or IRA Accounts

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Nothing is more significant over the long term from a financial planning aspect than ensuring you are setting aside and investing a sufficient amount to take care of your monetary needs in retirement. This can be easy to put off, especially if retirement is far away and taking care of your personal finances is low on your already long to-do list. However the earlier your start the better off you will be. Every year you delay saving for retirement could knock tens of thousands off your final nest egg because you miss out on the magic of compounding.

Almost two-thirds of Americans in the lowest pre-retirement income brackets will run short of funds after 10 years of retirement, while after 20 years, 29 percent in the next-to-highest income level will run short of money according to a study by the D.C.-based Employee Benefit Research Institute. “As the private-sector retirement plan system evolves from a largely paternalistic one to a system in which workers must make their own decisions, policymakers need to understand what percentage of the population is likely to fail to achieve retirement security under current conditions,” says Jack VanDerhei, principal author of the study.

In fact, 54% of workers have never tried to calculate how much money they will need for retirement, according to the survey. Even among workers 55 and older, 47% still haven’t done the math. Further, some 27% of workers surveyed say they have less than $1,000 in savings, and more than half of workers surveyed say that the total value of their household’s savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000. And as the chart shows, the lower the household income, the more likely it is that retirement savings will fall short.

Fortunately, the path that leads to financial safety in retirement is lined with lots of superb tax advantaged options (like IRA’s, 401K’s and Roth IRAs) since the government wants to encourage self funded retirement with the least amount of dependency on welfare programs. With rising federal deficits and more people dependent on welfare, it is even more important to rely on your own means to fund retirement because social security and other government support programs may be much smaller or completely gone when you retire.

The two basic questions that every 401(k) participant or IRA account holder has to answer hasn’t changed. “Am I doing enough to save so as to afford to retire someday?” And “Am I investing appropriately to gain the maximum returns on my investment irrespective of the direction in which the stock market moves?” Both questions are equally important, but the first one is more so.

How Much Should I Save For Retirement

To make an estimate as to how much you need to save, first try and figure out your monetary requirements that are likely to be when you retire. Once you have an idea of that amount, you can work backwards to compute the amount you’ll need to save each year as per the dollar valuation today to finally be there. As a rule thumb you should plan to have 60 to 80 percent of your current income in retirement.

Certainly there are different things to be considered in figuring out how much you should save by the time of retirement, such as medical expenses, spouse’s retirement benefits, pension benefits, inheritance and the social security. An additional significant and connected item to consider is whether to save by means of pre-tax dollars, which would of course be taxable at the time of withdrawal, or by the means of after-tax dollars in a Roth 401(k) for tax-free withdrawals. This all depends on your current and expected tax situation.

Table of Target Retirement Savings NeededThe table here provides a general guideline of how much you (or your household) will need to have saved at retirement for a specified monthly pre-tax income, assuming a 5% average rate of return over a 30 year retirement period in which the recipient is also getting social security. Please refer to your own retirement accounts/guides for specific information on how much you will have to save for retirement based on your current contributions and tax situation.

Once you have figured your desired monthly income and target retirement savings amount, you should then assess if you will hit this number based on your current savings and contributions. To get to your target number you will either have to invest more effectively and/or work longer to afford retirement. I will be publishing a detailed post soon on how to hit your target number, what your retirement contributions should be and other factors to consider – you can subscribe for free to get this and other updates.

Am I investing appropriately?

The world’s uncontrollable and unpredictable stock markets over the past few years has been disheartening to many 401(k) and IRA investors, who followed the “rules” and saved regularly. Many have seen years of savings cut in half within a few months and despite a stock market recovery, retirement has been delayed for many by a number of years.

Still, despite the gyrations of investment markets, the only answer to get a good allocation of your retirement portfolio is diversification across various sectors and countries. It is also important to ensure you are investing (via funds) internationally rather than just taking a domestic focus, since the U.S. stock market capitalization is only about half that of the entire global markets (and getting smaller). Making your portfolio too U.S. dependent is going to create a risk factor as you will be making a significant bet on a dwindling and lower returning sector of the world economy. In fact, those who had a cross-country diversified portfolio have seen their retirement savings recover much faster.

Another key asset class to have in your retirement portfolio is bonds, which are a little different than many other investments. With stocks (equities), you’re primarily looking for capital appreciation (and some dividend yield). This means you want the price of your stock to go up. When you buy a bond you’re not as concerned with the increase or decrease of the bond price, but primarily looking to generate regular income in the form of interest. Because the interest is known when you buy the bond and payments are made at regular intervals, bonds provide a portfolio stabilizing effect. The general rule of thumb is that the closer you are to needing your money (i.e. retirement); the more bonds should be in your portfolio. But bonds do carry risk, principally inflation risk – where the cost of living moves faster then the return (interest) from investing in the bond.

It is also important to maximize your retirement contributions and know the key rules and regulations surrounding tax advantaged retirement plans.  You can see these articles for more on 401K Facts and IRA/Roth Rules and Limits. Keep in mind that for those 50 and older, the government has allowed them to make “catch-up” contributions where they can contribute an additional $5,500 (tax-free) each year to retirement accounts for a total maximum pretax annual contribution of $22,000.

One more advantage of lower stock prices and regular 401(k) or IRA investing, is the turbo-power effect of dollar cost averaging. Since a 401(k) plan forces you to invest regularly, you would have bought more shares at reduced prices than most other non-401(k) investors who were both disposing off and being mere spectators in the sidelines. These relatively inexpensive shares have also helped the typical 401(k) account recover quicker than the regular portfolio

Assessing what you have learned

You probably looked at your 401K or IRA account balances, and despite a modest recovery relative to last year, they are probably below what you would like them to be. The good news is that the market is much more likely to stay flat or go higher over the medium to longer term. So keeping up regular and diversified retirement investing is still the best chance most people have for a financially secure retirement. Just make sure you take some time to assess your retirement strategy, investment allocations, contributions and how much you will actually need when you do retire.

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{ 11 comments… read them below or add one }

Edwin August 8, 2010 at 3:10 pm

There is not mention at all if a person is debt free. It will change the whole picture. All those # in many instance are exagerated. Pay all your debt and you will be in better shape.

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JoeTaxpayer July 26, 2010 at 12:12 am

Andy -
The numbers in the chart are a bit alarming. $5K/mo is $60K/yr. I advise that $1.5M is needed to generate that (a 4% withdrawal rate). The chart, however, shows $845K? Over a 7% withdrawal rate?
I wonder how that advice worked for the gal who retired in 2000.
Gail shows 5% above. Still higher than I’d like, but not 7%.

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andys2i July 26, 2010 at 9:27 pm

I think I may need to rework the numbers. See update and look for a more detailed follow up post coming soon.

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Mike Piper July 25, 2010 at 12:01 pm

I’d actually argue that the table above significantly underestimates the amount of savings necessary to generate a given level of income.

For example, at $500 withdrawn from a $85,000 portfolio per month (or $6,000 per year), that’s a withdrawal rate above 7%. That’s extremely high. Even if an investor’s portfolio averages a 7% return over the course of their retirement (which it very well may not do), she can still run out of money by withdrawing 7% per year due to sequence of returns risk.

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andys2i July 26, 2010 at 10:19 pm

I agree and am updating the table. My excel calc’s were a bit off – thanks to the readers like yourself who pointed this out.

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Denise July 22, 2010 at 5:16 pm

Great article. Thanks for sharing.

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Russell July 22, 2010 at 10:22 am

Im 34 years old and have saved over $50,000 so far in a 401k, IRA, and Roth IRA. I’m putting 20% into my 401k, my employe is matching 4.5%, so that’s around $14,000/yr. I’m also putting $4000/yr into a Roth IRA, and $300/mo into my emergency fund which has almost $18,000 (savings). I’m being very aggressive right now, because I feel like I might be behind on my retirement savings, but it’s hard to tell. I’ve used retirement calculators but never know if I can count on them.

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yeeooow July 22, 2010 at 11:06 am

You are doing great so far…. here’s the situation for you and all 34 year olds starting now.

investments tend to double every 10-12 years so work it backwords.
to have 1 million at 67
you must have 500k by 56
you must have 250k by 45
you must have 125k by 34
reaching any of these numbers represent the point at which you can stop saving for retirement if you can live on 1 million dollars

is 1 million at 67 high or low
1 million can be expected to generate 60K/year

inflation tends to half you money every 24 years
so at 34 60K/year starts to decline
when you’re 58 it would be like living on 30K today
at 67 it would be like living on 23K today

but it doesn’t stop there, because your investment stops growing at 67 when you start living on the income but inflation doesn’t stop because you will live for another 25 years so your money will halve again, to about 11K when you die..

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Gail July 21, 2010 at 11:40 pm

Here’s an even simpler way to figure how much you will need in retirement. Take your current annual income as what you will need in retirement (e.g $50,000). Subtract social security ($20,000); and multiply the result ($30,000) by 20. This gives you $600,000 as your retirement target.

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MarkLiotta July 21, 2010 at 11:32 pm

People won’t be quitting their jobs anytime soon because they’ve decided they can’t retire — for reasons that were unforeseen even a few years ago which include:

* A national economic slowdown that looks and feels a lot like a recession.
* A sharp decline in housing prices, which has reduced the net worth of millions of homeowners and their families.
* Rapidly rising prices for food, gasoline and utilities.
* Stock market losses, which have cut into the value of workers’ 401(k) savings.

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Ray July 21, 2010 at 11:15 pm

Great article Andy. I also recommend reading the easy options to plan for retirement at the AARP site which include:

1. Start general planning for retirement at least ten years in advance.

2. Estimate how much you expect to accumulate before retirement; assess your retirement income resources, including Social Security; do a quick calculation of your anticipated expenses, both fixed and variable.

Use these figures to guide your planning to determine whether you can retire when planned. If your assessment suggests that you may not be able to generate the income you may need from your current investment strategy, consider finding a way to invest more, possibly become more aggressive in your strategy or even postpone retirement a few years. You can also consider incorporating part time work in your plan or consider tapping the equity in your home.

Lay out your vision of retirement in writing—where you’ll live, what you’ll do with your time and how you expect to pay for it. Once you’ve made a plan, it’s easier to review it once a year to see how you’re measuring up. Revise your plan to reflect any change in your financial circumstances.

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