Six Easy Steps for Figuring Out How to Save for Retirement

how to save for retirementWhen I read that 49% of Americans are not contributing to any retirement plan at all, I was not surprised to find out that the biggest offender group were people between the ages of 18 to 34.  My guess is that it’s not that they don’t want to do it, but rather that they don’t know how to save for retirement.

The last time there was a round of 401k sign-up at work, my younger colleagues seemed hopelessly lost. They were given a nice big folder of papers containing numbers of charts, and told the old “you should probably contribute 10% of your paycheck” advice.

But when it came down to, they really just had had no idea how to save for retirement.  When I’d ask them if they felt 10% would be enough, I was met with blank stares like a deer in the headlights.

The Bigger Picture:

When you’re told something trivial like “you need to save 10% of your paycheck”, it just doesn’t tell you enough about how to save for retirement.  What does a 10% savings really mean for your future? Will that get you to retire at age 65? 55? 40? Even when you do retire, does that mean you’ll be rich enough to be sipping Margaritas on the beach, or eating dog food for dinner?

Without knowing ANYTHING about stocks, people still meet their retirement goals all the time by properly figuring out how to save for retirement and setting their saving rates accordingly. All it takes is a few basic assumptions to get started.  The hard part is having the discipline to keep it going!


Figuring Out How to Save for Retirement Made Easy:

So as not to overwhelm my younger colleagues, I tried to boil down volumes of retirement advice into the simplest and easiest list of steps I could think of for how to save for retirement.  So here is what you need to do to get started:

Step 1 – How Much Do You Make Right Now?

Your standard of living is dependent on how much you and your spouse make right now. Take the combined total of your household gross income (before taxes).

Example: Before taxes: You $50,000 + Your Spouse $50,000 = $100,000 Total.

Step 2 – Multiply Your Income by 80% to Figure Out Your Retirement Income.

Due to a variety of reasons, many experts theorize that you will only need approximately 80% of your gross income by the time you retire.

Example $100,000 x 80% = $80,000 in retirement income.

Step 3 – Divide Your Retirement Income by 0.04 to Figure Out Your Nest Egg Size.

When you hear people talk how to save for retirement by building a “nest egg”, they’re usually talking about creating a pile of money so big that you could take 4% out each year and virtually never run out (in theory because the nest egg keeps replenishing itself).

Example $80,000 / 0.04 = A $2,000,000 Nest Egg.

Step 4 – How Many Years Until You Want to Retire?

If you don’t know, simply pick a number!  It’s okay because you can always revise your savings goals. Keep in mind that most retirement accounts won’t let you withdraw until age 59-1/2. Once you decide on that age, simply subtract that number from your current age to figure out the number of years.

Example: Let’s assume you want to retire 30 years from now.

Step 5 – Are You an Aggressive or Conservative Investor?

To keep things VERY simple, how do you feel about risk? Are you comfortable investing in stocks that may have big wins and extreme losses, or do you prefer bonds which have smaller gains but lower losses? If you fancy yourself as aggressive, then we’ll use an 8% average return rate. If you’re more conservative, then we’ll use a 6% average return rate.

Example: I’ll say that I’m more aggressive and use an 8% return rate.

Step 6 – Calculate How Much Money You’ll Need to Invest Each Month.

This will be the amount that you and your spouse need to save each year or month to hit your target (Note that it can be split this savings goal between you and your spouse as you see fit). The calculation can be done very simply using Microsoft Excel.  When figuring out how to save for retirement, it usually involves a finance calculation that takes into account compound returns, and this is usually too difficult to figure out on paper.

Example: Using Excel, I find that I need to be saving at least $16,347 per year or $1,333 per month.


What Does All This Tell Me? 

The important thing to take away from the exercise is an overall big picture about what your needs will be and how to save for retirement to get accommodate them.  If you take the time to figure this out, you’ll know how much money you’ll need to save each month to generate a lifetime of income that will help you enjoy the same quality of life that you do now.

I encourage you to try this exercise several times with a variety of different variables. See how the numbers change and how one small thing can affect your bottom line.


Making It More Complicated – Beginners, Cover Your Eyes:

For all the Haters out there – Remember that this exercise is intended to be an introductory guide for the Beginners. Don’t overly complicate it just yet with your economic rocket science and “what about inflation” theories. Making the question of how to save for retirement too complicated in the beginning for young people will lead to exactly what’s happening now – nothing!

To the Beginners – As I’ve mentioned, this is just a very basic introduction. You should know that every single step in this how to save for retirement exercise is based on assumptions that are surrounded by a massive amount of debate. Here are a few examples:

• Some people may argue that you need anywhere from 60% to 100% of your current income during retirement. What if you want even more?

• Some people may argue that you should take out 2% instead of 4% during retirement.

• Some people may argue that a 4 to 6% average annual return is about the best you could hope for over the next 30 years.

• Some people will argue that you need to factor taxes and inflation into your calculations. Although they are correct, to do so would require a more advanced lesson.

Does this mean this exercise is useless? Not at all! It simply means that there are just a lot of opinions out there.

If there is one thing you should learn from My Money Design, it’s that there is never one right answer! If you’re concerned about which variables are right and wrong, simply try running the exercise over and over again and get a range of results. At some point, you’ll notice a reoccurring figure that will basically become a “safe” target for you. Although it may not be precise, at least it will be a target to strive for!


Readers: What advice do you give to beginners who are just starting to figure out how to save for retirement? How much will you need to save each month? Are you on target right now or no where close? What is your opinion on these variables? Are there other factors you consider when projecting how much you’ll need to save each month?


Related Posts:

1) Help!  I Just Got My 401k Packet At Work! What Do I Do?

2) A Strategy for Maxing Out Your Retirement Savings

3) How to Pick Good Mutual Funds for Your 401k or Retirement Plan

4) A Better Way to See If You’ll Run Out of Money During Retirement

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    • MMD says

      Thanks for the compliment! I really (unfortunately) believe that some people pass up the free money on sheer ignorance and/or laziness. It’s a shame because I love free money!

  1. says

    It makes me sad that such a high amount of people don’t contribute to their own future – I don’t know what the number is in Canada but I’m sure it’s similar.

    One thing to keep in mind (maybe not in the US but here for sure) is that we do get a small amount from the government at retirement, so typically 80% of your pre-retirement income is REALLY high. Especially if you have your mortgage paid off.
    Daisy @ Add Vodka recently posted..Life Lessons From My MotherMy Profile

    • MMD says

      Great point! Depending on whether you believe Social Security will be around in 30 years in the US, that would actually drop your needs to about 60%. And if you’ve got your mortgage paid off, you may be able to get that even lower to 40%. How great would that be?

  2. says

    The most basic advice I would give to those starting out is to start with just 1%. Put aside 1% of your income into a 401(k) if your company offers it, and if not, into a Roth. Use a target retirement fund to keep things simple – it will automatically get more conservative as you approach retirement. After 6 months, start contributing 2% of your pay. You won’t notice the difference. Continue adjusting every 6 months until you’re up to 10%.
    Ryan recently posted..Ripoff Report #2 – Lottery Winnings, Pyramid SchemesMy Profile

  3. says

    Well done! I think it’s great for people to start somewhere and doing a simple calculation such as this is perfect. I really liked your spreadsheet!

    I think inflation is the most important factor to take into consideration, but you’re right. Instead of it propelling people to take action sooner, you get the whole ‘deer in the headlights’ thing and they don’t do anything. That’s really dumb…but that’s what happens.
    Jason @ WSL recently posted..Our Journey to Financial Peace – April 2012My Profile

    • MMD says

      I’m glad you like it Jason! Anymore, I’m finding that the easier you make this stuff sound, the more people think they can get on board with it. We’ll save the complicated stuff for later.

    • MMD says

      I worry about that trend. Who do you think is going to have to carry all those people who didn’t save up for retirement in 40 years? They’ll be calling to increase taxes on old MMD and Carrie – the ones with the money!

  4. Justin @ The Family Finances says

    I think the simplicity of this article is great. You can worry about all the advanced questions all you want, but if you don’t actually start contributing towards your retirement it doesn’t really matter. I’m an excel nerd, so I have a spreadsheet and graph that I periodically update and run scenarios on. It’s fun!

    Also, more companies now are starting to automatically enroll workers in 401k plans, which is a huge positive step.
    Justin @ The Family Finances recently posted..Monitor Your Credit ReportMy Profile

  5. says

    This is awesome! But I downloaded the worksheet and it stops working on step 6. Excel doesn’t like the equation, it told me. What is the exact equation so I can either try to do the math myself or re enter it on excel?
    femmefrugality recently posted..ROCing the Trailer ParkMy Profile

    • MMD says

      I’m sorry to hear it didn’t work! What version of Office do you have? The equation for Step 6 is:


  6. Anthony Thompson says

    This post is great, because it really gets into calculating real numbers rather than the generic save money theories write-ups.

    The fact is that millions of people have never thought about saving for their retirement, because they were falsely informed over the years that the government would take care of that for them. It’s only recently that we’ve started hearing about saving for retirement, and many people were caught off guard. As a result, they don’t have money saved for retirement and they’re scared.

    The problem is the lack of financial education going back to the last 30 to 40 years, and it’s now catching up with a lot of folks nearing retirement.

    • MMD says

      Thanks Anthony for the compliment! You’re right about the amount of ignorance out there. I had no idea what a 401k was or a pension or anything until I took an ACTIVE interest in it. I was surprised to find out I was on my own, but at the same time I had relief because I knew I could be in control of my own destiny. But for a majority of the public, I think we’ve got some rough times ahead.

  7. Katie says

    I’m loving the worksheet! According to the worksheet if I invest aggressively I only need to save $800 a month to be able to retire at 55 and that is on pretty close to what my current income is. Or if I save conservatively I can retire at age 65 by saving $600 a month.Most of the time I get freaked out about retirement savings, but I can live with those numbers.

    • MMD says

      Not bad! One thing to consider is that if you can find a way to generate additional income during retirement (flipping houses, selling stuff on Craigslist), then you’ll need even less than what you’re saving right now.

  8. says

    I definitely agree that this is a great start. If you aren’t comfortable at all with dealing with retirement see if your 401(k) provider has someone you can talk to but whatever you do take some sort of action today and don’t put it off. Time is your friend if you have a lot of it, but your mortal enemy if you don’t when it comes to retirement.
    Lance@MoneyLife&More recently posted..How I Paid for My HobbyMy Profile

    • MMD says

      I wish more younger people realized that time was their greatest tool for investing. Even if you know nothing, the act of saving and compounding returns will have vast effects.

  9. says

    Glad you took the approach of making things as simple as possible. The last thing you want to do is nothing. So if you’re confused in the beginning, obtain a bit of knowledge, invest according to your risk tolerance, obtain more knowledge and adjust. If you really don’t know anything, you can always invest as much as possible in a cash equivalent fund of your 401(k).
    Shawanda @ You Have More Than You Think recently posted..How to Use Social Networking to Save Money [Video]My Profile

    • MMD says

      That’s right! Even if you start by investing conservatively and then move up to riskier items as you gain more confidence, that’s still better than doing nothing!


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