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Published: Nov 05, 2020 10 min read
Filip Fröhlich for Money

Health care costs continue to rise, people are living longer and corporate pensions are an endangered species. What does this mean for your money?

For one thing, it’s more important than ever to save for retirement — but not just by squirreling away money here and there, hoping that it will be enough by the time you’re ready to leave your job. To keep up with inflation, that money also needs to grow over time. That's why it's important to invest in the stock market.

"The sooner you start, the more your money is going to be working for you," says Sri Reddy, senior vice president of retirement and income solutions at Principal Financial Group. "You can make it up over time if you start later, however you’re going to have to save exponentially more to end up with the same kind of outcome.”

So don’t wait. If you start saving $100 a month with a 6% average annualized return on your investment, you’d have about $46,000 in 20 years, according to Charles Schwab. But if you wait 10 years to start saving and invest the same amount, you’d wind up with just $17,000 20 years from now, since you missed out on some of that early compound growth.

Here’s how much you should save, and how to get started.

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Retirement savings: how much should I rely on Social Security?

Social Security is an insurance program run by the federal government that provides income benefits to retirees, certain dependents of beneficiaries, people who are disabled and survivors of workers who have died. According to research earlier this year from the the National Institute on Retirement Security, 40% of older Americans rely completely on Social Security income in retirement to meet all of their expenses.

Once you turn 62, you're eligible for Social Security if you have enough "work credits," which you earn each year based on your annual income. Eligibility for most retirement benefits requires that you earned one credit on average for each year between age 21 and 62, according to the Social Security Administration (SSA).

While you're eligible to claim benefits when you turn 62, your monthly check will be about 30% less than if you wait until full retirement age (66 if you were born between 1943 and 1954, and gradually increasing until 67 if you were born between 1955 and 1960 — find your retirement age here). At your full retirement age, you receive 100% of your earned benefit. But if you can hang on until age 70, you’ll collect 24% to 32% more than your benefit at full retirement age.

Even if you're able to wait until age 70 for a fatter check, Social Security should not make up your entire retirement income plan. According to the SSA, retirees on average receive 40% of their pre-retirement income via the program. So make sure you are saving elsewhere.

Retirement savings: how much should I save?

The amount you need to have saved up by the time you retire depends on several factors. The two big ones are when you want to retire and what you want your lifestyle to look like in retirement.

“People's views of what they want to do in their second chapter varies very drastically,” Reddy says. After all, traveling the world will cost much more than sitting on the couch and reading books from the library.

But you don’t have to be certain about your future to make a plan. If you want to have a lifestyle in your retirement consistent with the one you have during your career, Fidelity’s rule of thumb is to try to save 10 times your income by the time you’re 67. That means saving one times your salary by the time you're 30, three times your salary by age 40, six times your salary by age 50 and eight times your salary by age 60.

And keep in mind that all the planning in the world is not going to make up for unexpected events, like losing a job, getting a divorce, or having health problems. Have a plan and work towards a goal, but recognize that it’s okay if it goes off track, Reddy says. When that happens, he recommends reassessing your income, savings, future outlook and goals and adjusting your plan as needed. Maybe you could push your retirement date out, for example, to save for a few more years.

Remember: if you're struggling with making a plan on your own, you might want to hire a financial advisor who can help you out.

Retirement savings: what percentage of my income should I save?

Once your paycheck hits your bank account, it can be hard to part with any of it. That's why it's best to automatically divert some money to your retirement account first, before you can touch it. Fidelity recommends saving 15% of your income to reach that 10 times your salary savings goal by the time you're 67. That percentage includes your employer’s match, if you have one.

That 15% might seem like a lot, especially when you’re just starting out in your career and are juggling other financial priorities. The important thing is to save what you can as early as you can and try to grow that percentage over time, says Melissa Ridolfi, vice president of retirement and college planning at Fidelity Investments. So if you’re starting out with a 401(k) contribution that doesn’t get you to that 15% total, try to bump it up each year, or whenever you get a raise.

And remember that once you enter the workforce after college, your income will likely keep increasing — but that doesn’t mean you should keep upping the cost of your lifestyle, Reddy says. The more you upgrade your car and house, for example, the more you’ll need to save for retirement to keep up with that kind of lifestyle.

“Enjoy your life,” Reddy says, but if you get a raise of 3-4%, pocket 1-2% then put the rest towards savings. “You probably won’t miss it if you don’t have it.”

Retirement savings: where should I save?

Saving so much for later in your life might seem overwhelming, but there are tools to help: tax-advantaged retirement savings accounts, which can help you make the most of your savings. Some are connected to your employer, while others are attached to you individually and follow you throughout your career.

A 401(k) account is connected to your employer. A traditional 401(k) allows savers to invest tax-deferred dollars and postpone paying taxes until they withdraw money from the account as retirees. Many employers offer a 401(k) employer match, so if you contribute 3%, for example, the company will also contribute 3%. Everyone should at least contribute enough to get the maximum match from their employers, Ridolfi says.

“If you don’t, it’s like leaving free money on the table,” she adds.

Then over time, aim to contribute a higher percentage of your income to your 401(k), even if your employer only matches up to a certain point.

If you’re a gig worker or otherwise don’t have an employer who offers a 401(k) benefit, an individual retirement account (IRA) might make sense for you. With a traditional IRA, you contribute pre-tax dollars, and with a Roth IRA, you pay taxes upfront but then withdraw money tax-free in retirement. You can open up either kind of account at any of the major brokerage companies, including Charles Schwab, Fidelity or TD Ameritrade.

If you’re early in your career and believe you'll be making more later in life, a Roth IRA might be your best bet. This way, you pay your income taxes when you're in a low tax bracket and can enjoy tax-free withdrawals when you're presumably in a higher bracket later in life.

If your employer offers a high-deductible health insurance plan with a health savings account (HSA), Reddy recommends taking advantage of that too. You can make tax-deductible contributions to these accounts to help pay out-of-pocket medical expenses. And once you turn 65, you can make withdrawals for qualified medical expenses tax-free, giving you even more of a tax advantage than a 401(k) or IRA.

Overall, it’s all about knowing your options, and picking the ones that makes the most sense for you.

“Having a plan is the most important thing you can do,” Ridolfi says. Decide how much you're going to save, how you’re going to save and increase those savings when you can.

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