Money Growth: How Much Should I Invest for Retirement?

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I had a low-key babysitting job when I was twelve but that income was entirely active income. Not a cent of it grew without me doing anything. I had to actually provide a service to someone in order to add to my piggy bank (ok, it was actually a doggy bank).

Retirement, however, is a passive form of income. When money is invested in something like a 401(k), it grows passively. Meaning, you don’t have to do anything. (For more information about a 401(k) and its tax benefits, check out my blog post.) You don’t have to do anything to make it grow aside from investing it in the right places. If you invest in a 401(k), you literally make money while you’re asleep. How ’bout that!

But how much do I need to invest in order to have a successful retirement?

First of all, the fourth “baby step” of the Dave Ramsey plan (if you have read my book, you’d know I’m a fan) is to put 15% of your gross income into retirement. That means 15% of your overall income, including your spouse’s, goes into your 401(k) after paying off all your debt (so that you pay off debt with more intensity).

Fifteen percent is generally agreed upon in the investing world to be the amount that will provide a reasonable retirement nest egg. However, depending on whose advice you’re taking, this amount does not include the money that is contributed as an employer match. If your employer matches 5%, don’t put yours at 10% and call it good. Do the full 15% of your income. That way, the employer match will just be icing on the cake when you hit retirement. Now, 15% feels like a lot (it is, especially for young people). You will likely have to work your way up to it. Currently, Bailey and I aren’t contributing 15% because we are also cash-flowing her school and are saving for a house. But 15% is the goal.

 

Let’s look at a pretend real-life example of how much to invest.

Let’s assume that you, at age 22, just graduated debt-free and your overall income is $50,000 per year. By the 15% rule, you would be putting $7500 into retirement per year ($625 per month). If you invested that at an 8% return and never got a raise (not likely), you would have $2,669,622 by the time you turned 65. The best part is that $2,347,122 was growth from interest! And that’s not even including employer matches. That’s remarkable!

That amount of contributions may be unrealistic for you. I know it is for us currently. If you could only afford $100 per month to put into your 401(k) at an 8% return and never increased the amount you contributed, you would still have $427,139 by the time you turned 65.

There is a very high likelihood that you will get a raise and that you’ll be able to contribute more than $100 per month (plus, in today’s money, $427k won’t get you very far in retirement). To put you just over $1,000,000 (making you a millionaire if you are debt free), you would only have to contribute $250 per month. Again, your contributions would equal only a fraction of the full nest egg when you reached retirement. Then, in retirement, you would (hopefully) be able to live off of the yearly dividends that your retirement account produces in interest.

On a $1,000,000 account, assuming 8% interest, that would provide an $80,000 income. Plus, it’s quite possible to get higher than 8% in interest!

 

Chris Hogan, a retirement expert, says this in his book Retire Inspired: “Retirement is not an age. It’s a financial number.” I like that quote quite a bit because we’ve been seasoned to believe that we have to put 40+ years into a job we don’t like (jobs and passion is for another blog post) in order to live comfortably for the last 20 years or so of our lives. But according to Chris, if we know what financial number we are shooting for, we can retire earlier.

On Chris’s website, he has an excellent tool to calculate your R:IQ (Retire Inspired Quotient). In it, all you have to do is answer some simple questions about your goals and desired living arrangements and it’ll give you an amount of savings you should shoot for and the amount you would need to invest monthly to hit it. Check it out here!

What are you doing to save for retirement? What are your concerns about the subject? I want to hear from you in the comments!

-Caleb

How to Avoid Being Old and Broke (And How a 401k Can Help)

cash-cent-child-1246954I wasn’t very good at saving as a kid. Money burned a proverbial hole in my pocket. I liked to get gum when we went to the grocery store because it felt good to spend a dollar. To this day, I tend to be a spender. In fact, in our budget, Bailey (my wife) and I call the money allocated to spending as our “blow funds” because it is for us to literally blow on anything we want. What makes me different from when I was as a kid is that I actually have a budget now to control that spending urge. I’m more future-focused! And part of being focused on the future is saving for retirement. That’s where the 401(k) comes in.

What is a 401(k) anyway? It is a saving system that allows you to invest money you earn so that it can exponentially grow for the future. This is how it works.

A 401(k) is offered by most employers. If one signs up for a 401(k), it gives the individual the opportunity to put a percentage of each paycheck into a retirement account. For me, I have my employer put 10% from each paycheck into my 401(k). This is called an investment because it will grow within the account. Generally speaking, one can expect a 7-10% rate of return on their 401(k) if the money is invested into good growth-stock mutual funds.

This is where the big bonuses of a 401(k) come into the conversation. They have major tax benefits! There are two kinds of 401(k)s: traditional 401(k) and Roth 401(k).

The traditional 401(k) is tax-deferred. This means that one defers paying tax to a later date and thus, the money put into the account is pre-tax. So when an employer directs 10% from an employee’s paycheck into the traditional 401(k), no tax is paid. In retirement, however, taxes must be paid when withdrawals are made.

The Roth 401(k) is similar but the employee pays tax before the employer directs the hypothetical 10% of the paycheck into the account. This means the money used is post-tax.

But when money is withdrawn in retirement, it is not taxed.

Let’s make this easy. Say you are able to save enough for retirement that your 401(k) is able to grow to $1,000,000 (which really doesn’t take much saving). Generally speaking, over a 40-year period with a 10% rate of return, you would have contributed 8% of your savings and the rest of it would be growth. So..

Contributions: $80,000

Growth: $920,000

Total: $1,000,000

With a traditional 401(k), your contributions would be pre-tax. Thus, you wouldn’t be taxed on your contributions, but when you retired, you would be required to pay taxes on the entire $1,000,000. This means that if you were in a 10% tax bracket, you would lose $100,000 to taxes and would have only $900,000 left.

With a Roth 401(k), your contributions would be post-tax, meaning you would pay taxes on only the contributions. If we assumed once again that you were in a 10% tax bracket, you would pay $8000 in taxes on your contributions but wouldn’t have to pay anything on the growth.

Here’s a summary on taxes paid:

Roth 401(k): $8,000

Traditional 401(k): $100,000

Now tell me, which would you rather pay? And which 401(k) do you think is better?

In some coming blog posts, I’ll cover the amount we want to save for retirement and what we can expect in growth.

I want to know in the comments, are you saving for retirement? What are your dreams for your “golden years”? Bailey and I want to travel. Let me know what you think!