Deciding what percentage of your salary to contribute to a pension is an important part of planning for retirement. The general recommendation is to save 10-15% of your income towards retirement, but the exact percentage will depend on your individual circumstances.
How Much Should You Save for Retirement?
As a general rule of thumb, it is recommended to save 10-15% of your pre-tax income for retirement each year. This percentage includes any matching contributions from your employer. Here are some guidelines based on age:
- In your 20s – Save 10-15% of your salary
- In your 30s – Save 12-15% of your salary
- In your 40s – Save 15% or more of your salary
- In your 50s – Max out contributions if possible
The more you can save in your 20s and 30s, the more your contributions will benefit from compound interest. Making catch-up contributions in your 40s and 50s can help make up for lost time if you got a late start.
Factors That Determine Retirement Savings Needs
Your specific savings goal for retirement depends on your individual situation. Here are some factors to consider:
- Current age – The younger you start saving, the more time your investments have to grow.
- Desired retirement age – The earlier you want to retire, the more you need to save each year.
- Life expectancy – The longer your retirement, the more savings you’ll need.
- Income – Higher earners generally need to save a greater dollar amount.
- Current savings – Your savings and investments to date will impact how much more you need.
- Retirement lifestyle – Your desired travel and leisure expenditures affect your needs.
- Health care costs – Be sure to factor in Medicare premiums and out-of-pocket costs.
- Other sources – Factor in any pension or Social Security benefits you expect to receive.
- Inflation – This impacts how much retirement will cost in the future.
Online retirement calculators can help you estimate your specific needs and savings targets. But a general guideline is to save 10-15% annually throughout your working years.
The Power of Starting Early
Starting to save early in your career is the best way to leverage compound interest and reach your retirement goals. Here is an example to demonstrate the benefits of an early start:
| Person | Age Started Saving | Annual Savings | Total at Age 65 |
|---|---|---|---|
| Amy | 25 | $5,000 | $1,135,000 |
| Josh | 35 | $5,000 | $555,000 |
| Lisa | 45 | $5,000 | $260,000 |
This example assumes a 6% average annual return. As you can see, Amy who started saving $5,000 per year at age 25 ended up with over $1 million by age 65. But Lisa, who put off saving until 45, ended up with less than $300,000 despite saving the same annual amount.
Employer Matching Contributions
If your employer offers matching retirement plan contributions, be sure to contribute at least enough to receive the full match. This is essentially free money that can kickstart your retirement savings.
For example, if your employer matches 50% of contributions up to 6% of your salary, you should save at least 6% of your salary to earn the full match. If you make $60,000 per year, saving 6% would equal $3,600 per year. Your employer would then match 50% of that, adding another $1,800 to your retirement account.
Catch-Up Contributions
Individuals age 50 and over can make catch-up contributions to 401(k)s and IRAs above the normal limits. For 2023, the catch-up contribution limit is:
- 401(k) – $7,500
- IRA – $1,000
If you are approaching retirement age and have not saved enough, maxing out catch-up contributions can help you reach your target savings faster.
How Much Income in Retirement?
As a general guideline, you should aim to replace around 60-80% of your pre-retirement income with retirement savings and benefits. However, your specific income replacement ratio could be higher or lower based on factors like:
- Your desired retirement lifestyle – Lower expenses may require less income.
- Debt load – Entering retirement debt-free reduces the needed income.
- Health care costs – Out-of-pocket costs impact your needs.
- Life expectancy – Longer retirements require more savings.
- Social Security and pension benefits – These provide guaranteed income.
Use retirement calculators to estimate your specific income replacement needs. But for many, an income replacement ratio of 70-80% is a reasonable starting point.
Investment Growth Rate
When projecting your retirement savings needs, it’s important to use a reasonable estimated growth rate for your investments. Here are some guidelines:
- Conservative portfolio – 3-5% average annual return
- Moderate portfolio – 6-8% average annual return
- Aggressive portfolio – 9-12% average annual return
As you near retirement, it’s prudent to adjust to a more conservative asset allocation with lower expected returns. For earlier retirement projections, assuming a higher growth rate is reasonable. But be sure to use a growth rate you can realistically expect to achieve based on your investment strategy.
Role of Pensions
If you will receive a traditional pension in retirement, you can factor this guaranteed income stream into your planning. Your pension benefits are determined by your years of service and salary history. Review your pension plan details to estimate your monthly payouts in retirement.
Any pension income may allow you to withdraw less from your retirement account each year. But be sure to confirm if your pension continues lifetime payouts for your spouse in the event of your death.
Social Security Benefits
While Social Security was never intended to fully replace one’s prior earnings, the monthly benefits are foundational to retirement income for most Americans. The age you claim will impact your benefit amount:
- Age 62 – Earliest age to claim, reduced benefit amount
- Age 67 – Full retirement age for anyone born in 1960 or later
- Age 70 – Maximum benefit amount
Your Social Security monthly payment will be based on your lifetime earnings. Sign up for a My Social Security account to view your estimated benefits.
The 4% Withdrawal Rule
A popular guideline for managing retirement portfolio withdrawals is the 4% rule. This advises limiting annual withdrawals to about 4% of your total retirement savings balance initially. So if you had $1 million saved, you would withdraw $40,000 the first year.
This initial withdrawal is then adjusted each year thereafter for inflation. So it might rise to $41,200 in year two if a 3% annual inflation rate is assumed. The 4% rule seeks to provide a steady, inflation-adjusted income stream for 30 years or more.
However, this rule was developed in the 1990s and some experts argue that following it today is too aggressive given lower bond yields and ahead-of-inflation healthcare cost increases. A lower initial withdrawal rate around 3% may be more prudent.
Getting Help from a Financial Planner
If you are still unsure what percentage of your salary you should be saving for retirement after considering all of these factors, a consultation with a financial planner can help. He or she can review your specific situation, including your retirement lifestyle goals and current progress, and then offer personalized advice on saving and investing to create a retirement plan customized for your needs.
Conclusion
While 10-15% of your income is a good general target, your ideal retirement savings rate depends on your age, income, desired retirement lifestyle, life expectancy, healthcare costs and other individual circumstances. Use retirement calculators to estimate your needs. Max out contributions to receive full employer matching and take advantage of catch-up contributions after age 50. Consider your projected pension and Social Security benefits. And enlist the help of a financial advisor if needed to craft a customized plan.
Getting started early, consistently saving over time, and investing wisely are key to accumulating enough for a comfortable retirement. With prudent planning, discipline and smart choices, you can build the nest egg you will need.