It's a good idea to track your progress toward retirement savings goals. Disorganization can have catastrophic consequences, and you don't want to be surprised by the amount you have saved after it's too late to make major changes. Ensure that you're on track at various points throughout your career to eliminate guesswork and make adjustments when necessary.
Different people have different needs
Don't look for a dollar amount that serves as a universal retirement planning rule. Instead, think about savings as a consistent activity throughout your career that will eventually create cash flow to fund your lifestyle once you've stopped working.
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The process of asset building should be your focus throughout your career. That's the accumulation phase of retirement planning -- it's all about saving a portion of your earnings and investing those savings for asset growth. Financial planners recommend saving 20% of your income, and a large portion of those savings should be invested and earmarked for retirement. If you consistently follow that guideline throughout your career, then you'll most likely have plenty of assets built to fund a healthy retirement.
The amount that you should have invested for retirement at age 40 is based on that 20% target savings rate. The amount depends on your income, and it varies from person to person.
Goal setting and reviewing the math
The general guidelines suggest that you should have three times your annual household income saved for retirement at age 40. That might seem like a conveniently round number, but it's not pulled from thin air. There's a bit of science and serious thought put into that benchmark.
Consider a hypothetical 25-year-old who makes $75,000 per year. For simplicity, assume that this person achieves a 20% savings rate each year. Some of that might go to home equity, HSAs, college funds, stocks in a brokerage account, or some other asset class, but assume that 10% of this person's income is contributed to their 401(k) and IRA.
If they invest those savings and achieve an 8% average rate of return, they'll have $227,000 accumulated by age 40, which is just over three times their salary. There's a clear line from the recommended savings rate to the recommended investment amount.
| Age | Investment Account Balance |
|---|---|
| 25 | $7,500 |
| 30 | $55,019 |
| 35 | $124,841 |
| 40 | $227,432 |
| 45 | $378,172 |
| 50 | $599,658 |
| 55 | $925,094 |
| 60 | $1,403,266 |
| 65 | $2,105,858 |
Source: Author's calculations.
In reality, most people aren't able to save the same amount each year. Income could fluctuate from a job change, children can drastically change household expenses, new home or car payments can complicate matters, and conditions in the stock and bond markets go through cycles. Returns also vary over time as capital allocation evolves -- people usually prioritize growth in their early years, but they take steps to limit volatility as they approach retirement. This typically results in lower growth.
Progress never follows a neat, orderly curve. Nonetheless, guidelines are helpful for comparison so you're not relying on guesswork when setting goals and tracking progress.
Thinking about cash flow
Retirement planning centers on solving a cash-flow puzzle. Once you stop working, you'll have to rely on your savings to cover any lifestyle needs unmet by Social Security or another form of guaranteed income. The 4% Rule suggests that retirees can safely distribute 4% of their invested assets each year without exhausting their financial resources. Violating the 4% Rule would likely result in outliving your money. That's a catastrophic risk to avoid at all costs.
Consider the hypothetical person who earns $75,000 outlined above. If you maintain those same assumptions straight through to age 65, that person's retirement account would build to roughly $2.1 million. The 4% Rule indicates that this person could safely distribute $84,000 each year before taxes. Remember, distributions from traditional IRA or 401(k) accounts are treated as ordinary income for tax purposes.
Again, savings rates and investment returns will never be that constant in real life. The average savings rate is also much lower than 20% for Americans, and most people aren't building assets by age 25. However, the example above is a useful illustration of the logic behind retirement planning goals. It also highlights the value of starting to save early in your career.
