Decade by Decade Retirement Plan
I don’t know if the Three Little Pigs are retired yet, but I’ll bet that if they are, the one who built the brick house is living a life of leisure. He, or maybe it’s a she, worked hard and built a home that would last long into retirement.
The two other little pigs who built homes of straw or sticks are working side hustles while living together in a run-down apartment that they can barely afford because the shoddy homes they built were blown down by the big, bad wolf.
This is all assuming that the little pig with the brick house didn’t let the sibling pigs live with him.
Planning and hard work are key to having enough money to enjoy a comfortable retirement. The earlier you start saving for it, the easier it will be. There are some things you should do throughout your life to make your retirement plan work, and there are others that are best done around certain decades of your life.
- Why plan decade by decade?
- The bottom line
Why plan decade by decade?
We’ve come up with a decade by decade retirement plan that you can put away and use as a checklist every year on your birthday, for example, or at least sometime during the first year of a new decade, such as in your 20s.
Why every decade? Some tips will remain constant throughout your life, and having reminders for those is a good idea. Other financial moves for retirement planning should be done at certain ages because your income will likely change, as should your exposure to risky investments.
Funding retirement accounts should be automated so that you don’t have to think about it much from year to year, though an annual review is a good idea. But a deep look every decade can make sure you’re on the right path.
Start by deciding how much to save
It’s good to know your end-goal and how close you are to meeting it each year. If you’re on track to meet your goal, then there shouldn’t be much to do. But if it looks like you may fall short, you can adjust and make catch-up contributions or do something else to help you get there.
A rule of thumb from financial planning experts is that you’ll spend from 55% to 80% of your final pre-retirement salary while you’re working in retirement, depending on your income, retirement lifestyle, and health care costs. So if you earned $100,000 in your last year on the job, for example, you may need up to $80,000 per year in retirement.
The 4% rule
But how much does that $80,000 annually in retirement equal in total retirement funds? One formula to use is the 4% rule.
It requires adding up all of your retirement investments, and withdrawing 4% of that total during the first year of retirement. Afterward, the amount withdrawn is adjusted for inflation. Taking out 4% should ensure you don’t outlive your money during a 30-year retirement.
To have 80% of your final annual salary of $100,000 saved for each year or retirement, or $80,000, the 4% rule equates to having $2 million saved: $80,000 ÷ 0.04.
This assumes a 5% return on investments after taxes and inflation, and no additional retirement income such as Social Security. You can lower the figure if you want to include Social Security, pensions, a part-time job in retirement and other income sources.
Social Security benefits, for example, typically replace about 40% of pre-retirement income, according to a 2020 report from the National Institute on Retirement Security.
Percentage of your salary
The one constant that financial planners recommend through every year of working is saving 15% of your gross annual salary until you reach retirement age.
You don’t have to come up with the full 15% yourself. This 15% amount includes an employer match, such as to a 401(k) retirement plan, and any other savings you expect to have for retirement. It doesn’t include Social Security payments.
However, many people fall short of saving 15%. A 2019 study by Charles Schwab of 401(k) participants found that half contributed 10% or less of their income to their 401(k)s.
Your 20s are when most people start their careers, and it can be difficult to imagine how far off retirement is, yet alone saving for it. But starting now is when compounding interest works the most in your favor.
Starting this early gives you a big leg up on accomplishing your retirement savings goal, and is a good time to start saving for other financial goals. Here are some things to do in your 20s as you plan for retirement many years from now:
- Contribute 15% of your salary to your employer’s retirement plan, though an employer match can be subtracted from your contribution. So if your employer contributes 3%, you can put in 12%.
- If you can’t hit 15%, start at whatever is comfortable and increase it by 1-2% each year.
- Invest up to 90% of your retirement funds in stocks, which can gain the most but can also fall dramatically. But given your young age and work and life expectancy, this is a good time to be invested heavily in stocks, ideally in mutual funds and not individual stocks.
- Reduce debt by paying off credit cards, and pay your bills on time and in full each month.
- Start an emergency fund to cover 3-6 months of expenses if you lose your job.
- Create a budget and follow it.
- Start other good financial habits that will stick with you for a lifetime so you can contribute more to retirement and retire early.
How much to save annually in your 20s
To give you an idea of how much in actual dollars you should save in your 20s, you should start by calculating how much 15% of your gross pay is.
Suppose you earn $33,280 per year, which is the median salary of 20- to 24-year-olds, according to one analysis of 2020 data from the Bureau of Labor Statistics, or BLS. Fifteen percent of $33,280 is $4,992. If you get a raise, you should recalculate your contribution, unless it’s already set at 15% and automatically increases.
Saving about $5,000 per year for the decade of your 20s leaves you with at least $50,000 by age 30. That’s well above the recommendation by Fidelity and other financial advisors to have 1X your current income saved by age 30. Here’s what Fidelity recommends:
- Age 30: 1X current income
- Age 40: 3X current income
- Age 50: 6X current income
- Age 60: 8X current income
- Age 67: 10X current income
3 types of retirement plans
The first time you look at retirement plan options in your 20s, you may be overwhelmed by what they are and how they work. Don’t sweat the details.
One of the big issues you’ll want to know is how each can affect your taxes. Contributions can be tax deductible now, meaning you can lower your income and get a tax break to help pay for any contributions you make now. Or you can choose a plan with tax deductions in retirement.
Here are the three basic retirement plans:
Also called a Roth 401(k), this is a common plan offered by employers. If your company matches your contributions, you’re essentially giving yourself a raise by maxing out the contributions you make.
Money is automatically withdrawn from your paycheck and directly deposited into a retirement account. It’s invested in stocks and bonds, and often you can choose the mix and types of index funds.
Contribution limits in 2021 are $19,500 per year.
While you won’t take a tax deduction on your income tax return for your 401(k) plan contributions, the money you put into the plan each year aren’t taxed for the year the contribution is made. Your tax liability at the end of the year can be reduced, as will your tax withholding each pay period, which can be used as part of your 401(k) contribution. Money from these funds are taxed when you withdraw them at retirement, when your income will likely be a lot less than it is now and you’ll be in a lower tax bracket.
Individual Retirement Account
Called an IRA for short, this traditional retirement account should be funded after you’ve maxed out your contributions to a 401(k). The main reason is if your employer is matching your funds, then a 401(k) is the best place to start saving for retirement.
IRAs have contribution limits of $6,000 in 2021.
They provide a tax deduction in the current year, meaning the contribution can be subtracted from your taxable income when you file taxes. With a 401(k), contributions aren’t taxed by your employer, giving you more take-home pay.
Withdrawals from an IRA during retirement are subject to federal and state taxes that you must pay.
A Roth IRA is opened with post-tax income. You don’t get the tax deductions now, but when you withdraw them in retirement. That includes not having to pay taxes on all of the money the account has earned over the years. You can borrow the contributions if you need to before retirement.
You must have an income below $140,000 in 2021 to be able to fund a Roth if you’re single, and married couples filing a joint tax return must have an income of less than $208,000 in 2021.
Income usually increases as you get older, and getting into your 30s should give you a significant jump.
For Americans ages 25 to 34, the median annual salary is $47,736 per year. That’s 43% more than the median annual salary for someone in their 20s.
Contributing 15% of this higher salary equals $7,160.
Here are some things to do in your 30s for your retirement:
- Continue contributing 15% of your salary to your employer’s retirement plan.
- If you haven’t reached 15% yet, now is the time to get to it instead of waiting longer.
- Continue with 90% of your retirement funds in equities, or stocks.
- Continue paying off debt, such as student loans, and keep funding an emergency fund.
- If you’re buying a house in your 30s, or even earlier, continue making retirement fund contributions.
How much to save annually in your 30s
As we mentioned above, a big salary bump is likely in your 30s, so use this increase to get your retirement plan contributions up to 15% of your salary if you’re not already there.
For the median salary of someone age 25-34, a 15% contribution is $7,160. If you’re in your late 30s or early 40s, the median salary is $59,020 per year, so 15% equals $8,853.
Remember that at age 30, financial experts recommend having one year of your annual salary saved in a retirement fund. If you’re earning the median salary of someone in their mid-30s, that’s about $47,000.
If you’ve put 15% of your salary in a retirement fund since your 20s, you should have reached at least $47,000 by age 30. If not, then your 30s is a good time to start catching up by increasing contributions.
These are your peak earning years. Earning power should increase even more in your 40s, though it may start to level out. This should allow you to pay down a mortgage, pay for college for your children, along with other financial goals you may have, such as having a savings account.
Hopefully your emergency fund is doing well so that a medical emergency, job loss or a big expense doesn’t leave you in debt.
Other moves to consider in your 40s include:
- Continue saving 15% annually for retirement, increasing in 2% increments if you’re not there already.
- Keep at least 60% of your retirement funds in stocks, since your work and life expectancies are still significant.
- Buy life insurance if you don’t already have it to cover your family’s expenses and the loss of your income if you die.
- Look into adding long-term care insurance, which will be cheaper now than it will be later, as a way to prevent financial disaster during retirement.
How much to save annually in your 40s
In their early 40s for Americans, the median salary is $59,020 per year, so a 15% retirement plan contribution equals $8,853 per year.
For someone age 45-54, the median salary is $59,488 per year, which isn’t much more than what it is for workers 35-44. A 15% retirement plan contribution at age 45 or so equals $8,923 per year at the median salary.
Between ages 45 and 54 is when you’ll likely hit your annual income peak, so be sure to have your 401(k) or other retirement plan contributions up to 15% by now.
As we mentioned earlier, by age 40 you should have 3X saved of your latest annual salary. For someone in their early 40s, that would equal around $177,000.
At age 50 it should be 6X. Using the median salary of $59,488 per year, then about $357,000 should be saved for your retirement goals.
If you’re lucky, your peak earning years will continue into your 50s, allowing your retirement plan contributions to reach a high.
But starting in their mid-50s, the median annual income will only go up slightly, from $59,020 for a 44-year-old to $59,488 for someone age 45-54, according to BLS data. At age 55 the median salary drops to $56,680 per year.
With your income peaking in your 50s and probably dropping in your late 50s, now is the time to play catch up if you haven’t been putting at least 15% of your gross income into retirement funds.
Some financial moves to make in your 50s include:
- Keep contributing 15% to your retirement plans.
- At age 50 and older, you can add an extra $6,500 per year in “catch-up” contributions to your 401(k). For total contributions in 2020, that can be up to $26,000 into a 401(k).
- At age 59-1/2 you can withdraw money from a 401(k) without owing a 10% early-withdrawal penalty. The penalty doesn’t apply, however, if you’re 55 or older in the year you leave your employer.
- If you have old retirement accounts from previous employers, make sure they meet your investment plan. You can also consolidate them.
- Eliminate debt, including student loans for your children, mortgage payments, and credit card debt.
How much to save annually in your 50s
At 50 your retirement accounts should have 6X your salary. At 60 it should be 8X. For a 55-year old earning the median annual salary of $56,680, 6 times that is $340,080. At 8X, it’s $453,440.
Incomes start dropping in the mid-50s because more workers this age start to leave the workforce. If you’re finding that your retirement accounts aren’t high enough to meet the goal of having 80% of your final annual salary saved for each year of retirement, then your 50s is the final stretch where you can start saving more.
As we discussed earlier, withdrawing 4% of your retirement funds should allow you to have enough money for 30 years. Use this equation to determine the total amount that should be saved at retirement:
80% of final annual salary ÷ 0.04
So if your final annual salary in the year before retirement is $56,680, then 80% of that is $45,344. That’s how much you’ll withdraw, approximately, every year in retirement. Divide that number (45,344) by 0.04, and you’ll need a total of $1,133,600 in your retirement accounts.
If you’ve got close to $1.1 million saved by your late 50s, then you’re in good shape.
Retirement is around the corner, so consider these steps:
- If you’re not on pace to hit $1 million or whatever you’ll need to retire for 30 years, start saving more than 15% of your income.
- Retirement plans allow catch-up contributions at this age.
- Look into a balanced approach of your assets, such as 50% equities and the other half in bonds or other safe investments.
- Research health care costs, Medicare payments, and what your life expectancy is.
How much to save annually in your 60s
Many people start to leave the workforce at age 62 when they become eligible for Social Security benefits. Waiting a few years longer can give them the maximum benefit amount, so it’s worthwhile to delay taking them until they hit the highest level. The Social Security website can show you how much you’ll receive monthly, depending on when you start taking benefits.
For people who continue working in their 60s, the average salary for Americans 65 and older is $52,936 per year.
At age 67 your retirement accounts should total 10X your last annual salary. At the median salary for a 65-year-old, that’s $529,360.
Remember that the amount of money in your retirement accounts isn’t all of the money you’ll have to live off of in retirement. Social Security accounts for 40% of income for many people, so with that added you should be close to having enough money for 30 years.
Required Minimum Distributions
Another thing to be aware of in your 60s are Required Minimum Distributions, or RMDs. These are the minimum amounts required by law to be withdrawn from retirement plans. They don’t start until age 70-1/2, but they take effect earlier if you retire before you turn 70.5.
Here are the general rules:
- IRAs: First RMD must be on April 1 of the year after the year you turn age 70-1/2.
- 401(k): First RMD on April 1 of the year after either the year you turn 70-1/2, or the year you retire.
Pros and cons
The biggest pro to planning and funding your retirement decade by decade is that you’ll get to retire without worrying if you’ll have enough money.
Contribute 15% of your annual gross income, or less if your employer puts money in, and compound interest will take care of the rest. If you hit the contribution limits on one type of retirement account, such as a 401(k), then open an IRA or Roth IRA if you have extra money to invest.
Funding an IRA, 401(k) or other retirement account may leave your budget lacking, especially when you’re starting your career and your salary isn’t very high.
Your friends may go on spending sprees that you can’t afford because you’re following the lead of the little pig that built a house with bricks. You're building your future house with direct deposits from your paycheck.
Delaying funding can make compounding do less work for you, and require you to make catch-up contributions at a later age. Neither of those are fun, and could put a crimp in your household budget in your 40s and beyond.
The bottom line
Unless you want to take your chances and rely on Social Security and Medicare, you should be aware of the money moves you’ll need to make to reach a successful retirement.
That means following a budget, putting 15% of your income in retirement funds, and investing them in stocks for most of your life. Like the pig that built the brick house, you’ll be safe after years of hard work, while those who used straw and sticks and didn’t save much, if anything, may have a more precarious retirement.