The amount you need to save for retirement and how quickly you need to do so depends on several factors, like the age when you start saving, your age at retirement, the rate of return on your investments, and your income. The later you retire, the fewer years you’ll need to support yourself on savings. And the younger you are when you start saving, the less you’ll need to set aside from each paycheck to hit your target amount. So how much will you need to save before you can stop working for good?
How to calculate your target
Not everyone needs the same dollar amount to live comfortably in retirement, but financial experts agree that most Americans are not saving enough to come close. The size of your nest egg ultimately will depend on the lifestyle you wish to maintain when you stop working. If you plan to retire at 65 and you live for 30 more years, you’ll need enough money set aside to cover your needs and wants. You might already have a budget based on your basic needs. But certain expenses – like unexpected healthcare costs – are more difficult to predict.
You can use an online calculator to estimate the amount that you should set aside before you stop working. Or you can think about how much you’ll need in terms of multiples of your income. At age 35, for example, you may need to have 1-4 times your annual income already saved. When you are 50, you might need to have 5-10 times saved what you are earning at that time.
Similarly, your annual contribution to retirement savings to reach your goal should be a specific percentage of your yearly income. Speaking with a financial advisor will help you determine what your unique retirement saving strategy should be.
How to find retirement savings in your income taxes
If you had more money in your paycheck each pay period, would you put more into your retirement savings? If your answer is yes, it might be time to adjust your income tax withholdings. People tend to treat their income tax refund like a forced savings plan. They select fewer income tax withholdings than they are allowed on their W-4. Then, the IRS gets to hold on to their money until tax season, when it is returned in the form of a refund.
But if you only withhold the amount you owe for taxes, you could take the “extra” income you’d be getting back, invest in a tax-deferred retirement account, and even earn interest. It is recommended that you update your Form W-4 anytime your income, employment, or family status changes. Major life events could impact how much you need to pay in income tax, and it’s easy to lose track of your withholdings.
Read also: 5 Reasons You Should Check Your Withholdings
If you prefer to wait for your maximum refund at tax time, this is still an excellent opportunity to make an investment in a retirement savings plan. Rolling just a portion of your money into a tax-deferred savings account is a great way to make the most of what you get back from the IRS. You still travel, pay down bills, or treat yourself with the remainder of your refund.
How to shelter retirement savings from tax
Your tax liability doesn’t automatically go down when you retire. The thing is, you have to start taking Social Security by age 70, and if you have a 401(k), 403(b), or an IRA, you’ll have to take required minimum distributions by age 70 ½. So even in retirement, you’ll be receiving income, which could push you into a higher tax bracket.
While you are employed, investing in a tax-deferred savings plan can be beneficial because of the tax deduction. If you want to avoid the mandatory withdrawals at 70 ½, you could convert your investment to a Roth savings plan. With these, there are no required distributions, and your withdrawals are tax-free. Your conversion would be taxed like ordinary income, so it’s best to do so during a year where you have less income.
Depending on your overall income, your Social Security benefits will be taxed at 0%, 50%, or 85%. Because they are taxed so heavily, it might make sense for you to withdraw from your tax-deferred savings and delay taking Social Security for as long as you can. And if you have bonds or real estate investment trusts that produce income, it could be beneficial to place those into tax-deferred accounts.
This article is up to date and accounts for tax law changes for tax year 2018 (tax returns filed in 2019). Learn more about tax reform enacted under the Tax Cuts and Jobs Act here.