Each person starts saving at a different age and makes a different amount in salary, so setting aside money for retirement is an individual decision. However, you should set a target percentage or a dollar amount you will set aside each month for your retirement years. You don’t have to pick this percentage or dollar amount randomly. Some guidelines can give you a starting place for arriving at your own percentage.
The 10 Percent Goal
According to Walter Updegrave, Money Magazine senior editor, setting aside 10 percent of your income can be a reasonable goal. However, your retirement fund will grow much larger if you start this practice in your 20s instead of in your 40s. In addition, the 10 percent rule assumes your income grows by about 3 percent a year each year until you reach retirement. It also assumes you earn an average of 8 percent on your savings each year. If you have circumstances such as starting at a later age, recovering from a financial setback, or a drop in salary, you may have to save more than 10 percent. Start with the 10 percent figure and make adjustments based on your particular situation.
The Twice-Your-Salary Goal
Updegrave adds that setting a goal of having twice your annual salary saved by age 40 can be a significant milestone, but it will not guarantee a comfortable retirement for everyone who achieves this milestone. He suggests that you continue to save 10 percent each year until you are 45, then raise your retirement contribution to 13 percent a year. If you are not on a pace to have twice your salary saved by age 40, you can see that you will have to greatly increase your retirement savings in your later years. You may find yourself needing to set aside as much as 25 percent.
If your employer matches your contributions to your 401(k), M. Blair Hodgson, principal and investment advisor at Ferro Financial, says you should definitely focus on your 401(k) as your retirement vehicle. However, she suggests that you save additional money in a taxable account to help boost your retirement savings. You won’t pay tax on that money when you withdraw it, because you contribute to it with money that's already been taxed. Keep records of money you contribute and file a notice with the Internal Revenue Service each year detailing how much money you contributed from after-tax funds.
Balanced Money Formula
J.D. Roth, writing for the Get Rich Slowly website, prefers the method set forth by Elizabeth Warren, known as the balanced money formula. It suggests that you live on half your income, save 20 percent of it, and spend 30 percent on extras. Roth suggests that the habit of saving is more important than hitting the actual percentages each month.
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