Is Maxing Out Your 401(k) Enough?
by , CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
April 21, 2010
How much should a dual income couple with no kids save for retirement outside of maxing out their 401(k)s?
How much to save is on a lot of people's minds these days, especially as many folks have seen what they thought were adequate savings dwindle over the past couple of years.
So your question is a good one—and essential. A specific answer, however, depends on more personal information than I have about you and your spouse. So while I can't tell you exactly how much you should be saving, I can give you some help in determining that for yourself.
How much are you currently saving for retirement?
You say you're maxing out your 401(k)s. That's great. If you're getting a company match, that's even better. But "maxing out" adds up to different dollar amounts depending on your age and your employer's plan. The current maximum contribution allowed is $17,000 (plus a catch-up of $5,500 if you're 50 or older). Which means it's possible that you and your spouse together could save $34,000 a year in your 401(k)s, or up to $45,000 if you’re both 50 or older. That's a pretty good sum—but it may or may not be enough.
If you're able to save more, that's even better. Consider opening a Roth IRA. The current income limit (for 2102) for joint filers is $173,000 to make a full contribution. The benefit of a Roth if you qualify is that, while contributions are made with after-tax dollars, withdrawals are tax-free. And another great choice is to simply save more in a brokerage account. In this case, your contributions are not tax-deductible, but you will have the advantage of paying taxes at the reduced long-term capital gains rate when you sell investments you’ve held longer than one year.
How long have you been saving?
Your age and when you started saving are two other important factors. For those who start saving in their 20s, putting aside 10-15 percent of their yearly salary may well be sufficient—provided they consistently save that same percentage every year. But someone who waits until their 30s to get started needs to up that percentage to between 15 percent and 25 percent. Put off starting to save until your 40s and you're looking at needing to save 25-35 percent a year. That can be quite a challenge!
How much will you need?
How much to save really depends on when you plan to retire and how much you think you'll need for the retirement lifestyle you want. For planning purposes, it's wise to assume you'll need the same amount you're living on now. That's because, while certain costs such as mortgage payments and work-related expenses may go down, others such as travel, entertainment and health care may go up.
Here's a simple calculation to help you determine how large your retirement nest egg needs to be:
Your annual expenses minus income from Social Security, pensions or real estate equals how much additional income you need to generate from your portfolio. Multiply that amount by 25 for a rough estimate of the amount you'll need in your portfolio to have a high (roughly 90 percent) probability of making the money last for 30 years, adjusted for inflation.
Let's put in some numbers. Say you and your spouse want an annual income of $75,000 and your combined Social Security income is estimated to be $30,000. This means you'd have to generate another $45,000 to meet your expenses. Some industry experts suggest that you need a portfolio 25 times the amount of your first-year expenses to be reasonably confident that your money will last throughout your retirement. So in this case you'd need $45,000 times 25 for a portfolio of $1,125,000.
Here's the other side of this calculation. You should withdraw no more than 4 percent of your portfolio your first year of retirement. Then you can increase that dollar amount each year for inflation. This will help make sure you don't run out of money prematurely.
This might seem overly strict, but the idea is to have as much confidence as possible that your money will last for 30 years. Of course you might have a shorter retirement time horizon in mind or be willing to accept a lower probability of success; in either of those cases, you could consider withdrawing more.
Now crunch the numbers
These are all hypothetical examples, so I'd suggest you either consult with a financial advisor, or use an online calculator to get some real numbers for yourself. The usual formula is to enter your retirement goal, the amount you currently have saved, the amount you intend to add each year, the estimated rate of return and the number of years until retirement. You'll then clearly see if you're on target or need to up your yearly savings. Doing this can be eye-opening as well as empowering. With the figures in front of you, you can adjust your savings plan as needed—or relax with the knowledge that you're in pretty good shape. Either way, now's the time to take stock—and take action if needed. Good luck!
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