It's impossible to know the precise amount of savings. There
are too many unknowns, including how much you'll earn during your career, the
age at which you'll retire and how long and how well you'll live in
retirement. But 15% is a reasonable target, assuming you want to have a decent
shot at maintaining your pre-retirement lifestyle after you call it a career.
Boston College Center for Retirement Research recommends
a 15% savings rate for the typical household. If you can't manage 15%, start
with a lower percentage but try to increase your savings rate by at least one
percentage point each year until you get to 15%.
If your company offers a 401(k) or similar plan, you'll want
to jump all over that. For one thing, the amount you contribute annually to a
401(k) -- $17,500 is the maximum this year, $18,000 in 2015 -- is
deducted from your income. So you don't pay tax on your contribution and any
investment gains until you withdraw the money, ideally in retirement.
In the meantime, your dough is sheltered from income taxes,
which results in a larger retirement nest egg. The other big advantage of
saving in a 401(k) is that most employers match a portion of what you
contribute, which makes it easier for you to hit that 15% savings target.
Some employers also offer what's known as a Roth 401(k).
With the Roth version, you invest after-tax dollars, which means you don't get
a tax deduction. But you get to withdraw your money tax-free in retirement.
So if you think you'll be in a lower tax bracket in
retirement than you are today, a traditional, or regular, 401(k) is the better
choice. If you think you'll be in a higher tax bracket after retiring, you'll
do better with the Roth. If you end up facing the same tax rate, it's a wash.
It's tough to predict what tax rate you'll face when you
retire decades from now, so here's a quick take on choosing between the two
types of 401(k)s.
If you expect your earnings to rise substantially during
your career then you're probably now in the lowest tax bracket you'll ever be
in. That suggests you should go with the Roth. If you do that and your employer
offers a match, you'll still end up with money in a traditional 401(k) anyway,
as all employer matching funds must go into a traditional 401(k).
If your employer doesn't have a 401(k) plan, do as much of
your retirement savings as possible through an IRA. The maximum contribution
you can make is $5,500 both this year and next. IRAs also come in two types --
a traditional IRA, which gives you a tax deduction, and a Roth IRA, in which
you invest after-tax dollars. The same principle I described above applies to
deciding between the two.
Whatever amount you end up putting away, be sure to invest
it sensibly, which is to say put it in a broadly diversified blend of stock and
bond funds, preferably ones with low annual costs. And don't let any stock
market ups and downs spook you. You've got many years to recover from any
setbacks. So keep saving and stick to the diversified blend of stocks and bonds
regardless of what the financial markets are doing.
As you're putting away money for retirement, try also to gradually
build an emergency fund in a savings account or money-market fund equal to
three months' living expenses. Doing that will require you to restrict your
spending a bit more initially. But having such a fund will allow you to meet
unexpected expenses or weather a layoff without having to dip into your
retirement investments.
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