You’ve heard it a hundred times: Americans aren’t saving enough for retirement.
Study after study reports the same findings. For example, a study released by the Government Accountability Office in 2019 found that 48% of Americans have no retirement savings whatsoever. Zero. Zilch. Nada.
Clearly, $0 in retirement savings is not enough. But how much is “enough”? How do you know how much you should be saving, and at what ages, to reach your retirement goals?
While the answer varies from person to person, some universal rules apply. You don’t need a degree in finance to plan your retirement, but you do need to master a few basic concepts.
Even more importantly, you need the discipline to actually follow through on your retirement plan.
Calculating Your Retirement Horizon
Pundits love to say, “You should have X dollars by this age.” But in the real world, that only serves as a recipe for discouragement.
Instead of comparing age groups, think in terms of your retirement horizon, or the number of years remaining before you want to retire. If you’re 45 and want to retire at 65, your retirement horizon is 20 years. If you’re 32 and want to retire at 42, your retirement horizon is 10 years.
Get out of the habit of thinking in standardized terms about retirement. You can retire in virtually any timeline you like if you’re willing to funnel enough money toward retirement. In fact, financial independence/retire early (FIRE) advocates often cover the financial distance in only five or 10 years.
It all comes down to how much you’re willing to save.
The Relationship Between Savings Rate and Retirement Horizon
Most people work a 40- to 50-year career because they save and invest very little money. Proponents of the FIRE movement take a different tack: They save an extraordinarily high percentage of their income to build wealth quickly.
Your savings rate is the percentage of your income that goes toward savings, investments, or debt repayment. It’s the first key to financial independence, or being able to pay your bills entirely with your passive income from investments.
The more you save, the faster you build wealth and the faster you can retire. It’s that simple.
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Sample Retirement Numbers
Despite that simplicity, the concept of building wealth for retirement still leaves a nagging question of how much you need to save for different benchmarks. After all, everyone has their own target for retirement savings and income.
To illustrate the relationship between savings rate and retirement horizon, I ran the numbers for four different time frames, ranging from 10 years to a full 40-year career. For each retirement horizon, I calculated how much you’d need to save every month to reach targets between $500,000 and $3,000,000.
Keep in mind that the actual numbers would vary based on your returns. A savvy investor who averages 15% returns can get away with saving far less money than an average investor earning 7% to 10% per year. I used a reasonable 8% annual return in the calculations below. For reference, the S&P 500 has returned around 10% annually, on average, since its inception in 1928.
To Retire in 10 Years
If you want to retire in 10 years and you have nothing in the bank currently, you have your work cut out for you.
Regardless of whether you started late or simply want to retire young, expect to save aggressively to reach a seven-figure nest egg. Here’s what you should plan to save and invest each month for four different target amounts:
- $500,000: Save $2,734 per month
- $1 Million: Save $5,467 per month
- $2 Million: Save $10,934 per month
- $3 Million: Save $16,401 per month
The savings rate depends on what you earn. Consider the average American household income of $82,852. For a married couple who takes the standard deduction and lives in California, $6,571 of that would go to federal income taxes for tax year 2020, plus $6,338 for FICA taxes and $2,049 for California state income taxes, for $14,958 in total income taxes. That leaves them with $67,894 per year to work with, or $5,658 per month.
You must save $2,734 per month to save $500,000 in 10 years. For this household, that’s around half of their available monthly income of $5,658. They don’t earn enough to reach $1 million in 10 years, at least not with 8% returns.
To Retire in 20 Years
With more time at your disposal, you can rely more on compounding and less on your savings rate. Time does more of the heavy lifting for you.
You would need to invest the following amounts each month to reach each of the four targets:
- $500,000: Save $849 per month
- $1 Million: Save $1,698 per month
- $2 Million: Save $3,396 per month
- $3 Million: Save $5,094 per month
That’s less than one-third of the monthly savings for a 10-year retirement horizon. Compounding is a powerful thing.
The average American household in our scenario above would need a savings rate of around 15.8% to reach $500,000 in 20 years. They could reach $1 million with a savings rate of 31.5%, $2 million by saving 63% of their income, and $3 million by saving 94.5%. That last savings rate sounds a lot like starvation, but in the most technical sense, it’s possible for an average household.
To Retire in 30 Years
If you plan to work for another 30 years, you have plenty of time to let compounding work its wonders on your behalf. It takes far less money in monthly savings to reach your target:
- $500,000: Save $336 per month
- $1 Million: Save $671 per month
- $2 Million: Save $1,342 per month
- $3 Million: Save $2,014 per month
This kind of retirement horizon makes it practical for average Americans to become millionaires. Our example average household would need a savings rate of only 6.2% to reach $500,000, 12.5% to reach $1 million, 24.9% to reach $2 million, and 37.3% to reach a whopping $3 million.
To Retire in 40 Years
With a full 40 years to compound, you don’t have to save aggressively to become a millionaire. A person earning minimum wage could become a millionaire if they start saving 40 years before retiring. Here’s what the monthly savings amounts look like for this timeline:
- $500,000: Save $144 per month
- $1 Million: Save $287 per month
- $2 Million: Save $574 per month
- $3 Million: Save $861 per month
These numbers are one-nineteenth of the amounts needed for a 10-year retirement horizon. The sooner you want to retire, the more you have to rely on savings rate rather than compounding to get you there.
For our average American household, a 40-year retirement horizon requires a savings rate of 2.7% to reach $500,000, 5.3% to reach $1 million, 10.7% to reach $2 million, and 16.9% to reach $3 million. These are all manageable savings rates for an average household willing to budget.
How Much Do I Personally Need to Retire?
This is one of the fundamental questions in retirement planning, and everyone needs to answer it with their unique target number in mind. That requires you to work backward. Start with a yearly spending target: How much do you plan to spend each year in retirement?
Too many people make the mistake of basing this number on their current income. Your retirement spending and your current income are two very different numbers. You might earn $100,000 right now but plan to spend only $25,000 each year in a small seaside town overseas once you retire. After all, in many countries, $2,000 per month can buy a luxurious lifestyle.
Once you have a spending target in mind for retirement, you can start brainstorming ideas for how to cobble together that income. Some of it will come from Social Security benefits, which currently average $1,503 per month, or $18,036 per year. If you only need $25,000 per year, then Social Security benefits alone put you nearly three-quarters of the way there — assuming Social Security is still in effect when you retire.
Additional income might come from a pension, although retirement has changed over the past few decades and many workers don’t receive a pension anymore.
You could also work part-time in retirement to stay busy and earn some extra income. But for most of us, the bulk of our retirement income will come from our investments. That raises the question of how much you need to save to provide enough income to cover your remaining expenses.
Safe Withdrawal Rates and Sequence of Returns Risk
If you’ve ever heard of the 4% rule, then you understand the basic premise behind safe withdrawal rates.
Safe withdrawal rates address a simple question: How much of your nest egg can you withdraw each year without running out of money before you die? A classic analysis by Bill Bengen in the 1990s found that, based on historical stock and bond returns, a retiree can withdraw about 4% of their nest egg each year with a near-certain likelihood of their money lasting at least 30 years.
Keep in mind that not everyone needs 30 years. If you retire at the tender age of 45, you might need your nest egg to last 50 years or more. Someone who works until they’re 75 might only need their money to last 20 years.
The longer you want your money to last, the less you should withdraw each year. That’s common sense. As a general rule, a 3.5% withdrawal rate should preserve your nest egg indefinitely because it compounds faster than you drain it (see this analysis by Michael Kitces for the math). Meanwhile, a 5% withdrawal rate nearly always leaves your nest egg intact for at least 20 years. For a chart of different withdrawal rates and how long each leaves your savings intact, see this breakdown by Wade Pfau.
These analyses are based on historical returns, and there’s no guarantee the 21st century will see the same stock or bond returns as the 20th century. Retirees also face a unique risk known as sequence of returns risk, when the market crashes early in their retirement. If it does, retirees often drain their nest egg too quickly and too early, and it never fully recovers (more on sequence of returns risk shortly).
Calculating Your Target Nest Egg
Regardless of what withdrawal rate you choose, you can use it to determine how much you need to save as a nest egg to generate your desired income.
Say you plan to use the classic 4% withdrawal rate, aiming for your nest egg to last at least 30 years. To keep the math easy, imagine you want $10,000 per year in income from your investments to supplement your Social Security benefits.
If $10,000 is 4% of your nest egg, then 100% — your target nest egg — is $10,000 multiplied by 25, or $250,000.
Your multiplier is calculated as 100 divided by your withdrawal rate. So if your withdrawal rate is 4%, you’d divide 100 by 4 to reach 25.
If you want $10,000 per year in investment income in retirement but only want to withdraw 3.5% per year so your nest egg will last indefinitely, then you’d divide 100 by 3.5 to reach a multiplier of 28.6. Multiplying $10,000 by 28.6, you’d get a target nest egg of $286,000.
It’s just a matter of plugging the right numbers into this formula. But it requires planning on your part. You need to know how much income you need each year from your investments, and you need to estimate how long you will continue to live after retiring.
How to Reach Your Retirement Target Faster
As with everything else in life, knowledge is power in retirement planning.
To reach your target nest egg faster, try these tips and watch as your money works hard for you rather than vice versa.
1. Capitalize on Tax-Sheltered Accounts
Taxes take a huge bite out of your income each year. Look no further than that example of an average American household above, which loses nearly $15,000 each year to income taxes.
The less you pay in income taxes, the more you can put toward your retirement investments. Start simple with a traditional IRA through a broker like M1 Finance. If you have access to an employer-sponsored retirement account through your job, such as a 401(k) or SIMPLE IRA, those help you contribute more each year tax-free than your traditional IRA alone.
You can even use a health savings account (HSA) through Lively as a triple tax-protected account to boost your retirement savings. Use it to cover all your health care-related expenses in retirement, of which there will likely be plenty.
Don’t be afraid to use a Roth IRA or Roth 401(k) either. You don’t get the up-front tax deduction, but your money compounds tax-free, and you pay no taxes on it in retirement. Given that you may well owe higher taxes in retirement than you do now, Roth IRAs often help you more in the long term. Plus, they come with more flexibility: you can withdraw contributions tax- and penalty-free, so your Roth IRA serves as a backup emergency fund.
Pro tip: If you’re currently investing in a 401(k) or an IRA, make sure you sign up for a free analysis from Blooom. Once you connect your accounts, they’ll make sure you have the proper asset allocation, are properly diversified, and aren’t paying too much in fees.
2. Take Advantage of Employer Matching
If your employer offers matching contributions to your 401(k) or 403(b) or your SIMPLE IRA, take them up on the offer. It’s effectively free money.
Many employers offer to match up to a certain percentage of your annual income if you make contributions yourself. For example, they may say that for every dollar you contribute to your 401(k), they’ll contribute another dollar, up to a maximum of 4% of your salary. In that case, you get an extra 4% bonus on top of your regular paycheck, and you don’t even have to pay taxes on it.
That free employer match goes straight into your retirement investments, where it will grow and compound over the coming decades.
3. Avoid Lifestyle Inflation
When the average person gets a raise, the first thing they do is find a way to spend the extra income. It could be a new car, or a new apartment, or more dinners out each month.
As a result, no matter how much their annual salary grows, they don’t get richer. They just rack up more living expenses, running on a financial treadmill.
The phenomenon is called lifestyle inflation, and it’s dangerous because it happens with little conscious thought. We earn more, we spend more, and we get to “keep up with the Joneses” by showing off our oh-so-enviable lifestyle.
But real wealth exists on paper in your investments. You can’t drive it at 90 mph down the highway or throw dinner parties in it. It’s not sexy, and you can’t show it off. But it’s what lets you retire, and the more wealth you build, the more options you have to retire early or live luxuriously after calling it quits on the whole “work” thing.
4. House Hack
Housing is the largest expense in most people’s budgets. That makes it the greatest opportunity for saving more money each month.
Look for ways to house hack by having someone else pay your housing costs. It could mean buying a multifamily home and renting out the other unit, bringing in a housemate, or renting out a room on Airbnb. My business partner has rented out storage space (this can be done through Neighbor.com), and she currently hosts a foreign exchange student for a monthly stipend. My wife and I get free housing through her job as an international educator.
There are plenty of ways to house hack. The only limit is your imagination and your willingness to live a little differently than the average American.
5. Automate Your Savings
If you rely on your discipline to manually transfer money into savings each month, don’t expect consistent results. You’ll forget, or you’ll find excuses for why this month should be an exception.
Take saving out of your hands entirely. You can ask your employer to split your direct deposit so part of your paycheck goes directly into your savings account. Or you can set up automated transfers for each payday so the money leaves your checking account on the same day you get paid.
You can also use automatic savings apps like Acorns to transfer the money for you. Do whatever works for you, but make sure your savings plan doesn’t rely on your willpower.
6. Automate Your Investments
Once upon a time, only the wealthy had access to financial advisors. The rest of us had to figure out investing on our own, often with disastrous results.
Those days have passed. Today you can use a robo-advisor to invest on your behalf, based on your age, savings goals, risk tolerance, and other personal characteristics. When you set up the brokerage account, you can review the investment choices to make sure you’re comfortable with them.
Some services like M1 Finance are even available for free. Carefully review the best robo-advisors to choose one that fits your individual needs. I use Schwab’s Intelligent Portfolios, which is available for free with at least $5,000 under management.
You can even set up automated transfers directly to the robo-advisor to kill two birds with one stone.
7. Diversify Your Investments
Imagine for a moment that you put your entire nest egg in Enron stock in the early 2000s — before they famously declared bankruptcy after a massive financial scandal.
That’s why you need to diversify.
Fortunately, it’s easier than ever to diversify your investments. Start with index funds to inexpensively spread your investments far and wide, and don’t be afraid to invest some money in international funds for broader exposure.
As you near retirement age, traditional wisdom suggests you should increasingly add bonds to your asset allocation. They tend to be more stable and income-oriented.
But diversification doesn’t have to end at stocks and bonds. I find that real estate makes an outstanding alternative investment, offering some of the best of both worlds. You can buy an investment property directly through Roofstock or invest in real estate indirectly. From public real estate investment trusts (REITs) and private options like Fundrise to crowdfunding websites like Groundfloor and private equity funds, there are plenty of ways to diversify your investments with real estate.
If you want to expand your portfolio even further, you could invest in fine art through Masterworks or farmland through a company like AcreTrader.
8. Start a Side Hustle
Sure, side gigs can bring in some extra money. But they can also be fun.
My friend Zack and his wife give food and beverage tours. My mother tutors children. I invest in rental properties and write about personal finance. We all enjoy the time spent on our side gigs, so it doesn’t feel like drudgery. The extra money can go straight into your tax-sheltered investment accounts.
Best of all, a side hustle can be a perfect post-retirement gig. You can ramp it up to earn more on your own schedule or scale it back if you prefer.
You can even turn a hobby into a money-making business if you approach it systematically.
The beauty of post-retirement gigs is they reduce your dependence on your investment income. If the worst happens and the market crashes early in your retirement, exposing you to sequence of returns risk, you have another source of revenue. Rather than drain your (heavily devalued) investments to pay your bills, you can lean on your gig income.
Once the market inevitably recovers, you can go back to withdrawing money from your investments. But in the meantime, you dodge the worst and keep your nest egg alive and healthy.
Final Word
There are plenty of empty tokens of advice when it comes to how much you should save for retirement: Save 15% of your income to retire comfortably. Save $2,000 per month to retire a millionaire. Save $1 million dollars to retire comfortably. Follow the 4% rule.
But financial advice isn’t helpful if all you get are platitudes and generalizations. Your financial needs, considerations, circumstances, habits, and risk tolerance are uniquely your own. It’s up to you, then, to see beyond the cliches to plan your own retirement.
No one can tell you the perfect portfolio asset allocations or how much to save. Rather than rely on other people’s generalized rules, use the framework above to help you form your own retirement plan and determine whether or not you’re on the right track on your personal financial journey. And when in doubt, consult a financial planner to help you plan how much money you need in your retirement fund — and how to get there faster.
