How To Save For Retirement: 5 Essential Steps

Spontaneity can be a lot of fun. But it is the last thing you want when planning for retirement. Saving for retirement means delayed gratification, planning, and discipline, but that message may be hard to swallow in today’s fast-paced society. 

Fortunately, tools like a 401(k) can make the process less painful, since much of the saving is automatic after you set up the plan. If you are young, you may wonder if it’s too soon to plan for something 30 or 40 years in the future. 

The truth is, the earlier you start, the better: your savings will have more time to compound (as the earnings on your account earn more and more money). If you start saving early, you’ll have more freedom later to decide what you want to do. On the other hand, if you are already in your 40s or older, you may wonder if it’s too late for you to plan. 

The bottom line is that it’s never too late. But you may need to scale back some of your goals or increase the amount you save each year. 

This article is designed to help you set retirement goals and develop a detailed plan to achieve them. It will walk you through the steps of deciding on a retirement target date, calculating the income you’ll need in retirement, developing a savings plan to achieve that income, and tracking your savings progress over the years.

1. Decide When To Retire

The first step in planning for retirement is deciding when you want to retire. This can be trickier than it sounds. Attitudes about what retirement means and when it should happen have been changing over the last decade or two.

Retirement used to be clear-cut — you worked until you were 65 (or maybe 62), and then you were forced to retire with a gold watch and a pension. Social Security checks started arriving in the mail soon after your 65th birthday. Nowadays, things are different. No standard retirement age applies to everyone and every type of account. Consider the following:

  • If you were born in 1960 or later, you can take full Social Security benefits when you turn 67, not 65.
  • You’re allowed to withdraw money from your 401(k) without penalty at age 591/2 (or age 55, if you leave your employer).
  • You’re required to start withdrawing money from your 401(k) when you’re 701/2 — unless, that is, you’re still working for the company sponsoring the 401(k). Then you can wait until you retire to take out your money unless you own more than 5 percent of the business.

Whew! With all those different ages, how can you know when to retire? You need to estimate when you’ll have to start withdrawing the money in your retirement accounts, and whether that money will be supporting you entirely or whether you’ll have other sources of income.

Choosing an age now can help you plan how much you need to save and how much time you have in which to save it (your time horizon, in financial planning lingo). The advantage of estimating a retirement age now is that you can see whether that goal is reasonable. If it’s not, you may have to rethink it. The key is to remain flexible.

In choosing a target date for retirement, consider the following:

  • When you can access your various sources of retirement income (discussed in step 2)
  • What you’ll do when you retire (discussed in step 3)
  • Whether living to the age of 100 runs in your family

When you think about the age at which you want to retire and how long you’ll need to finance your retirement, keep your genes in mind. If you have a history of longevity in your family, plan financially to live until 100. (If you’re the cautious type, you may want to do this anyway, even if you don’t think you’ll live that long.)

2. Determine when you can access retirement income

When you retire and no longer earn a paycheck, you’ll need to get income from somewhere. If you plan well, you’ll have that income available from several sources.

Social Security

The first source of income you’ll have during retirement is Social Security, the federal government’s social insurance program that pays monthly benefit payments to retirees. Every worker who earns enough credits (by working) is eligible for Social Security benefits in retirement. 

Many people mistakenly think that they’ll start receiving Social Security checks when they turn 65. In fact, for anyone born after 1937, the age to receive full Social Security benefits (called the normal retirement age) is at least a couple of months past their 65th birthday. 

If you were born in 1960 or later, as mentioned, you won’t be eligible for full Social Security benefits until your 67th birthday. You can choose to receive reduced benefits at age 62 (even if you were born in 1960 or later). 

If you retire at age 62, your benefits are reduced to 80 percent of the full benefit if 65 is your normal retirement age, and 70 percent of the full benefit if 67 is your normal retirement age. Keep in mind that you’ll always receive the reduced benefits if you retire at age 62; they won’t increase when you reach your normal retirement age. 

In sum, you can’t expect to receive any retirement benefits from Social Security before age 62, and you can increase the amount you receive if you wait until 65, 66, or 67 (whatever your “normal retirement age” is), or even 70.

Some years ago, the Social Security Administration (SSA) began mailing annual statements to workers who are over 25 years old. These statements estimate how much money they’d receive monthly at age 62, at full retirement age, and at age 70, based on their income to date. If you threw yours away or can’t find it, you can register a social security account at SSA

You can factor the estimated benefit amount into your planned retirement income, but remember that Social Security was never meant to be your only source of retirement income. What’s more, the future of Social Security is somewhat uncertain. Although Social Security benefits may not disappear completely during the next 20 to 30 years, they may be reduced.

Other sources

Now, what about your other sources of income during retirement? The following list highlights possible retirement resources above and beyond Social Security:

401(k): As long as you’re working for the employer that sponsors the plan, you generally can’t take money out of a 401(k) before you’re 591/2. If your plan does permit you to withdraw money, you have to pay taxes and an extra early withdrawal penalty on the money you take out. If you leave your job at age 55 or older, you can withdraw the money without any penalty tax, but you still have to pay income tax. You can also roll it over into an IRA.

Other tax-favored retirement accounts: Accounts similar to a 401(k), such as a 403(b) or IRA, have rules similar to those of 401(k)s. Generally, you can’t count on having easy access to your money before age 591/2, or possibly age 55. The rules are different for 457 “deferred-comp” plans. In some circumstances, you may be able to get at your retirement account money before age 55 without paying an early-withdrawal penalty.

Traditional defined-benefit pension plan: If your employer offers one of these plans, your human resources or benefits representative may be able to tell you what your expected payment will be if you qualify to receive benefits.

Life insurance: Some people buy a type of life insurance policy that allows them to build up a cash account (a cash value policy) instead of buying term life insurance, which is worth nothing after you stop making payments. If you have a cash value policy (such as whole life or variable life), it should have a cash account that you can tap at retirement.

Regular taxable savings: A taxable account is any kind of account (such as a bank account, mutual fund account, or stock brokerage account) that doesn’t have special tax advantages.

Part-time work: No matter when you retire, you may want to take a part-time job that will keep you active and give you extra income.

Inherited wealth: You shouldn’t count on any inheritance until you actually receive it. But if you do inherit a substantial amount of money, integrate at least part of it into your overall financial plan, to give your- self a higher retirement income.

If you plan to retire before age 65, don’t forget to factor in the cost of medical insurance. The availability and cost of medical care is a major issue if you plan to retire before you and your spouse are eligible for Medicare, the government-sponsored medical program for those aged 65 and older. You can take the first step toward figuring out the age when you can feasibly retire by writing down your sources of income and when you can access them.

3. Figuring out what to do when you retire

Assume that your retirement begins tomorrow. What will your life be like? Retirement calculators don’t ask this necessary question. Most importantly, what will you do six months after the novelty of retirement wears off, when you’re tired of golfing, shopping, traveling, or being a couch potato? Many people find it difficult to go straight from full-time work to full retirement, particularly when they haven’t developed outside interests.

According to an Employee Benefit Research Institute Retirement Confidence Survey, 24 percent of retirees said they had worked at least sporadically since retiring. Of those, more than half said the reason they continued to work was that they enjoyed working and want to stay involved. About 25 percent said they worked to keep health insurance or other benefits, while 22 percent said they wanted money to buy extras.

Having an idea of what you’ll do in retirement is important so that you can avoid these common mistakes:

  • Retiring too early, realizing that your money isn’t going to last, and being forced to go back to work. In the meantime, you’ve lost out on contributing more to your 401(k) — and possible employer contributions as well.
  • Retiring, becoming totally bored within six months, and begging for your old job back.

4. Calculating the amount of money you need for retirement

After you decide when to retire, your next step is to consider how you’ll feel when you’re retired and no longer have a paycheck. You’ll probably need close to 100 percent of your income (in the year before you retire) to maintain your standard of living. How much savings will it take to provide this level of income? The answer is “a lot.”

We recommend trying to save ten times the income that you expect to earn in the year before you retire. This formula is a good starting point if you plan to retire at your Social Security normal retirement age (65, 66, or 67). If you retire earlier, you’ll need to save more. If you have a company pension or other sources of income, or if you retire later, you may be able to get away with saving less.

If you’re retiring in the near future

Assume that you’re retiring at the end of this year and that your salary is $50,000. According to the benchmark, you should save $500,000 to hit the “ten times” goal. Sound like a lot of money? It is, but it would provide approximately an average of $30,000 a year of inflation-adjusted income (see the nearby sidebar “What goes up — or inflation-adjusted income”) over 25 years, assuming that

  • The rate of inflation is 3 percent.
  • Only a small cushion will remain at the end of 25 years.
  • You invest half your nest egg in stocks and half in bonds during this period.

A yearly income of $30,000 may not sound like much, but remember that your taxes will be lower when you retire, and you won’t need to save income for retirement anymore. And your expenses will likely be less than when you were working. 

Your income likely will also be supplemented by your taxable savings and Social Security, as well as any of the other sources listed earlier in the article, giving you an adequate level of retirement income.

If your retirement is further off

We can hear you calling, “Hey, a little help here….I’m not retiring tomorrow, so how do I know how much I’ll be earning the year before I retire?” Not to worry.

Assume that you’re 41 and you want to retire when you’re 62. You need to project your current income to what you think you’ll be earning 20 years from now — at age 61, the year before you retire. Decide on an average rate that you expect your income to increase — say, 3 percent. You will get a factor of 1.80. 

Multiply your current income — say, $50,000 — by 1.8, and you’ll see that your expected income at retirement is $90,000. Using the ten-times rule, your desired nest egg becomes $900,000 (10 × $90,000). This is an easy way to get a rough idea of how big a retirement account to build, regardless of your current age or income.

Using a retirement calculator

Another way to develop a workable retirement plan is to use one of the many retirement calculators and other tools available on the Internet or through the financial organization that handles your 401(k) money. Remember that each calculator uses different methods and assumptions, so different calculators can produce widely varying results. Check the assumptions each calculator uses to see if they make sense for your situation.

Here’s where you’ll find a few of the better general calculators we have:

The major benefit of using a retirement calculator is that it gives you an investment reality check. Will the amount that you’re saving and the investment mix enable you to accumulate what you need? A good retirement calculator answers this question and also helps you decide how to close any savings gaps. Generally, you can close a gap by increasing your contributions, adjusting your investments to achieve a higher long-term return, or using a combination of the two.

Some independent companies such as mPower, Financial Engines, and Morningstar are excellent sources of retirement-planning information and calculations. They go further than simple calculators and actually give you specific advice on how to invest money in your 401(k) plan and other retirement accounts.

5. Developing a Retirement Savings Plan

When you recover from the shock of how much you’ll need in your retirement account, your first thought will probably be, “How on earth do I accumulate ten times my annual income — and then some — by the time I retire?” 

The key is to start as early as you can. The earlier you start saving, the longer your money has to benefit from compounding, even if you start by putting away only small amounts.

Cutting down on your expenses

We realize that many workers barely earn enough to pay for basic necessities and can’t eke out anything extra for a 401(k) plan contribution. But it’s important to try. Or you may be in your 40s and want to save more to catch up, but you can’t figure out where to find the money. You may be surprised by some of the places you can save money. Often a few minor spending adjustments can free up money for savings.

Like most everything, it all boils down to making choices. Our guide lists suggestions for cutting your spending. Cutting out one or two, or reducing the cost of a few, can help begin your savings program.

You’re probably wondering whether all this nickel-and-diming is really worth it. We’re not suggesting that you give up everything on the list — only that you look at what you spend to see if you can cut some costs without feeling too much pain. 

Giving up a few nonessential items today is far better than struggling without necessities during your retirement years. We’ve never met a 401(k) participant who claims to have saved too much. And we’ve never heard participants say that wished they’d spent more money earlier. Instead, many older participants say they wish they’d started saving sooner. 

This may be difficult to believe, but the important thing about money is not how much you earn. It’s how you manage what you have. Spenders will always spend what they have or more, regardless of how much they earn. A spender who gets a substantial increase in income will adjust his spending habits to a new level within a very short period of time.

If you have a tendency to spend, you should automatically put a portion of any pay increase into a 401(k) or similar forced savings vehicle before you get used to having it in your hot little hands. Otherwise, you may never break your spending cycle.

Considering sample plans

After you begin to save, keep checking to make sure you’re on track. Certain benchmarks can generally help you gauge where you should be. The following savings goals are designed for 25-year-olds just starting their savings programs. 

If you’re over age 25, these benchmarks can still tell you if you’re on target with your retirement planning. If you’re significantly behind these benchmarks, you’re certainly not alone. Remember that these are ideals; they’re not here to make anyone feel defeated. 

Instead, the intention is to motivate you to sit down and develop a workable plan for catching up. This may mean that you have to work longer than you’d like or substantially increase your savings rate. If you feel depressed looking at these, just be glad you’re starting now. If you’d waited, imagine how much more catching up you would have to do!

  • Savings goal by age 35: one times your pre-retirement income. Your goal should be to accumulate the amount of your annual income by age 35.
  • Savings goal by age 45: three times your pre-retirement income. Assume that in the next 10 years, you increase your contribution rate to 10 percent. You continue to receive a 50 percent match (equivalent to a contribution of 3 percent of your pay from your employer), your annual pay continues to increase by 4 percent per year, and your investment return is 9 percent per year. By age 45, you’d be ahead of schedule, with an accumulation of more than 31/2 times your annual pay.
  • Savings goal by age 55: seven times your pre-retirement income. Assume that everything stays the same for the next ten years — except that you increase your contribution rate from 10 percent to 15 percent at age 50, your annual salary increases by 4 percent per year, and your investment return continues at 9 percent until age 50. The return then drops to 8 percent from age 50 to 55 because you sell some of your more risky stock investments in favor of investments that provide a more stable but lower return. At this point, you will have accumulated 7.2 times your annual pay. As you near retirement, your goal is within reach.
  • Savings goal by age 60: ten times your pre-retirement income. Assume that your contribution rate remains at 15 percent, your employer’s contribution rate remains at 3 percent of your salary, and your pay continues to increase by 4 percent per year. Your investment return remains at 8 percent. At this point, you should be in a good position to consider various alternatives — including retiring, working fewer hours at your current job, or shifting to another income-producing activity that interests you.

These projections are based on assumptions that may differ considerably from your actual experience. Use all these figures as guidelines to help you understand the important features of investing for retirement.

Sticking with your retirement savings plan for the long haul

The purpose of the previous sample plans is to show you how a specific plan gives you a tangible way to measure your progress each year. Knowing some assumptions in the previous savings goal examples is helpful here:

  • Money is saved for retirement every year. You should even add to your retirement savings during periods when you’re not eligible to contribute to a 401(k).
  • All the money is left in the plan until retirement. None of the money is withdrawn for other purposes.
  • The assumed return requires at least 60 to 70 percent in stock investments (mutual funds or a diversified mix of individual stocks) up to age 55. After age 55, the stock holdings drop to 50 to 60 percent.

Your retirement nest egg comes from your own contributions and your employer’s contributions, and the investment return that’s earned on these contributions.

You’ve probably heard about the magic of compounded growth, a term used to explain how money can grow over time. This magic is significant only over long periods of time — 20 to 30 years or longer. This is why starting to save at an early age and sticking with your program is so important. If you wait ten years before you start, you substantially reduce your investment return. You can make up the difference only with a much larger savings rate or by working and saving longer.

Learn more about money-saving tips.

Leave a Comment