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If you’ve ever researched retirement planning, you’ve likely come across the rule of thumb that suggests saving 10-15% of your income for retirement.
But what does that really mean, and how do employer contributions factor into this calculation? In this post, we’ll break down the nuances of this widely discussed guideline and how to apply it to your own financial planning.
One common point of confusion is whether the 15% savings recommendation refers to your gross income or your take home pay. The general consensus among financial experts and what most retirement planners mean is 15% of your gross income. This is the total amount you earn before any deductions like taxes, health insurance, or retirement contributions.
For example, if you earn $50,000 per year, 15% would amount to $7,500 annually. This figure should ideally be saved for retirement, even though it might seem challenging to allocate that amount from your paycheck.
Many people wonder whether they can include their employer’s contributions when calculating their total retirement savings. Fortunately, the answer is yes. If your employer matches a portion of your retirement contributions—say, up to 5% of your salary—you can count this match toward your 15% goal. So, if your employer contributes 5%, you’d only need to save 10% of your own income to hit the 15% target.
For example, if your take-home pay is $1,560 after taxes and other deductions, and you want to save 15% of your gross income:
You decide to contribute 5% of your pay to your retirement account to take full advantage of your employer’s match. If this amounts to $78, your employer also contributes $78. To reach the 15% goal, you’d then contribute an additional 10% of your take-home pay, or $156, making your total contribution $234.
With the employer match included, your total retirement savings become $312, which represents 15% of your gross income.
While the 15% rule is a solid guideline for many, it’s not a one-size-fits-all solution. Personal circumstances—such as your age, when you start saving, and your retirement goals—play a crucial role. If you start saving for retirement later in life, you may need to contribute a higher percentage of your income. Conversely, if you begin in your early 20s, you might have more flexibility.
Some financial enthusiasts and members of the financial independence community save a much larger portion of their income—sometimes 50-70%. These individuals often live frugally, own paid-off homes or cars, and invest aggressively to retire early. While this level of saving isn’t feasible for everyone, it highlights the importance of avoiding lifestyle inflation and living well within your means.
A chief concern with higher savings rates is how they impact your current quality of life. Saving a significant portion of your income can be challenging, especially if you live in a high-cost-of-living area or have substantial expenses. However, there are ways to gradually increase your savings rate. For instance, you could raise your contributions by 1% each time you receive a raise, making the increase less noticeable in your day-to-day budget.
Age and Starting Point: If you’re young and just beginning to save, even a lower percentage can grow substantially thanks to compound interest. But if you’re starting in your 40s or 50s, you’ll need to ramp up your savings to make up for lost time.
Income Variability: Your income level also influences your retirement strategy. If you earn a high income, saving 10% might max out your 401(k) contributions, while someone earning less might need to save a higher percentage to achieve their goals.
Budgeting Tips: Remember, the key to effective retirement planning is to budget your expenses around what’s left after saving. Living on 85% (or less) of your income becomes much easier when you’ve built a budget that prioritizes saving.
The 15% savings guideline is a great starting point for most people, but your financial strategy should evolve as your situation changes. Whether you’re aiming to save for early retirement or simply ensure a comfortable future, understanding how to optimize your savings rate is crucial. Start by saving as much as you can comfortably manage, and strive to increase your contributions over time. After all, the sooner you start, the more you’ll benefit from the power of compounding.
Remember, retirement planning is about balancing today’s needs with future security. Even small steps today can make a big difference tomorrow.