Your 401(k) Contributions May Not Be Enough. Here’s How Much You Should Save for Retirement
Most young professionals tend to not think about retirement planning yet. This includes saving for retirement funds. However, a study says that you need to work up your savings earlier if you want to have a more financially secure retirement life.
According to the American investment management firm Vanguard, most of the American workers contribute only 6% of their salaries to their 401(k). If you factor in the median matching contributions of companies, it will only be a little under 10% of their monthly wages.
Unfortunately, if you want to maintain your standard of living even in retirement, this savings rate may not be enough. As recommended by Vanguard, you need to save 12% to 15% of your salary. You may also want to increase that rate depending on your situation or expectations of future stock performance.
The Center for Retirement Research (CRR) in Boston College conducted a study to determine how much should be saved to be able to replace 80% of your income before retirement. It studied scenarios with varied annual income, age when the savings were started, and the rate of return for your retirement portfolio.
Starting Later Would Need a Bigger Savings Rate
Assuming that the rate of return after inflation is at 4%, a 25-year-old with annual earnings of $43K in 2010 would need to set aside 12% per year if they want to retire at the age of 67 with a solid financial state. For those who started 10 years later at 35 years old, a savings rate of 18% per year is highly recommended. The study also showed that retiring earlier than 67 would need a bigger savings rate while retiring later would require you to save less.
Of course, the higher your earnings are, the more you need to save to maintain your living standards. Compared to those who earn lower, maximum earners only get a smaller portion of their income replaced by Social Security.
As per the CRR, someone who has maximum earning of around $106,800 should start saving 16% of their income upon reaching the age of 25 or 25% when they decide to start later at 35. This is if they intend to enter retirement in solid financial shape at the age of 67.
Don’t Just Rely on Future Portfolio Returns
The 4% real rate of return is deemed as an optimistic figure in the next decade. The 15% annualized gain of US large-cap stocks in the past decade should not be carried over to the next since stock valuations are high and bond yields are less than half of the long-term norms in the past.
Institutional investment firm Research Affiliates found that the median for expected annualized returns for US large-cap stocks in the next decade is just below 1%. This is also the same trend expected from low-yielding bonds.
The risk of low portfolio returns means that you should give more thought on how much you are saving pre-retirement. Retirement experts recommend considering low returns in planning for your retirement.
As of 2019, the maximum 401(k) contributions younger workers can make is $19K. On the other hand, workers who are 50 years old and up can only contribute up to $25K.
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