It’s perhaps the biggest financial quandary facing every young saver: Personal finance advice –- including our own — implores you to save as much for retirement as possible. But the younger you are, the more likely you have other important goals ahead: Repaying student loans, buying a home, getting married, taking time for extended travel, starting a business – the list could go on.
So what’s the right answer?
I spend a lot of time wrestling with this question myself. Like most people, my retirement savings got off to a rocky start. I put a little bit away in 401ks in every job I worked, but never more than the minimum required to qualify for my employer’s match. And I didn’t increase my contributions (or open an IRA) until my late 20s when I had paid off the lion’s share of my debt.
Over the last few years, I’ve been playing catch up and maximizing my retirement savings. This year, I’ll try to max out my SEP-IRA (a kind of retirement account for the self-employed). I’ll divide any remaining savings between 529 plans for our kids and brokerage accounts designated for those “other” goals – most likely a vacation or two and a new house with a little more space for our two growing kids.
At the moment, I’m incredibly lucky that there’s enough money to max out retirement accounts and save for some other things, too. That hasn’t always been the case. Most of the time, we have to prioritize our goals and allocate our savings accordingly.
Here’s a rule that can help you balance retirement savings and other goals: Take the total amount you can save each month and allocate half to retirement and half to other goals until you’ve maxed out your allowable annual retirement savings, then put additional money towards other goals.
I realize this is a dramatic simplification. Some of you will want to save more for retirement to take advantage of the tax benefits, while others will need to save more for non-retirement goals and life events. I arrived at the 50/50 split because — for common income levels and savings rates — it provides the best chance of saving enough for retirement without exceeding IRS maximums for common retirement accounts. In the following chart, you can see how the 50/50 split works compared to saving 20 percent for one goal and 80 percent for another:
How much you’re actually able to save for each goal depends on two things:
- Your income
- Your savings rate.
Your savings rate is the percentage of your gross income that you save. Working on continually increasing it should be a priority. As you can deduce from the above charge, somebody earning $50,000 and saving 25 of her income annually is saving more ($12,500) than somebody earning twice as much but only saving 10 percent ($10,000).
What follows are three scenarios and proposed savings rates for retirement and non-retirement goals. Of course, personal finance is personal, so how much you allocate towards non-retirement goals will depend largely on what you’re saving for and how soon you want to get there. If you’re getting married in a year and need $10,000 for your wedding by then, you may have to increase your non-retirement savings rate temporarily. Likewise, if you’re saving for a “someday” goal without a pressing timeline, you can save a little less because you have more time on your hands.
Beginner: 10 percent
We all have to start somewhere, and if you’re scraping by with an entry-level salary and student loans, it doesn’t make sense to stretch an already-thin budget by over-saving for retirement. If your budget is tight, first decide on what percentage of your income you can save. Let’s say you can afford 10 percent. I would put 5 percent into retirement and 5 percent towards other goals like paying down debt, building an emergency fund and other goals. If you earn $27,000 a year, for example, that’s a total of $2,700 — $1,350 towards retirement and $1,350 for other goals.
As your income grows (or you trim other expenses), focus on increasing your overall savings rate and use the additional savings for your nonretirement goals.
Intermediate: 15 to 20 percent
So you’re more established. You don’t subsist on Ramen anymore, and maybe you have six months’ living expenses in a savings account for emergencies. You don’t have credit card debt, and you’re focused on the next big thing: A down payment, wedding, paying cash for a new car – whatever it may be. Here’s where I would try to stretch your savings rate from 10 percent towards 20 percent. If you earn $50,000 a year, aim for at least $5,000 towards retirement and $5,000 towards other goals.
Advanced: 20 – 25 percent (or more)
You’re the one your friends think “has it together.” Congrats. Perhaps you’ve paid off all of your debt. Or maybe you just have a healthy income and your expenses in check so you don’t worry about money as much and have a nice amount left over to save. You’re comfortable with a savings rate of 20 percent or more. You may have maxed out your IRA or even your 401k in years past, but you’re wondering if you can save some of that money for other things you’d like to do. If you earn $75,000 and aim to save 25 percent, that’s $9,375 in both retirement and non-retirement savings accounts.
If, however, you don’t have a 401(k) at work and can only take advantage of an IRA – savers under the age of 50 will only be able to contribute $5,500 towards retirement (with tax advantages). In this case, you would save $5,500 for retirement and $13,250 in other accounts. (You may, of course, wish to designate more than $5,500 for retirement even though you can’t put it in a tax-advantaged account.)
What if I don’t have specific savings goals?
Ok, so maybe you’re a powersaver but you’re content: You’re happy where you live, you have some emergency savings, and you have no plans to spend a big chunk of money anytime soon. You should just funnel all of your savings into retirement accounts, right?
Although it’s certainly smart to take advantage of retirement accounts’ tax advantages – we have to remember that once your money is in a retirement account, it’s no longer liquid. With few exceptions, withdrawing money from a retirement account before you’re age 59 ½ will incur taxes and a 10 percent penalty.
Liquidity gives you options in the short term.
Lots of times, you hear about people withdrawing from or borrowing against their retirement savings to buy a home, fund a mid-career sabbatical, or start a business. If you’re savvy about your saving now, however, you may be able to have the cash on hand to do something like that without the need to sabotage your retirement savings.
With my retirement balances catching up to where I want them to be for my age – I’ll be following this strategy this year and allocating about 10-15 percent of our income to retirement and 10-15 percent towards saving for other goals.
Why we shouldn’t skip saving for retirement
Finally, if you’re young and hell-bent on a big wedding or a down payment on your dream house in the next few years, it may be tempting to delay contributing to your 401k until that goal is met.
Saving something in a 401k or IRA – even 5 percent of your salary – is more important than ever. Yes, there are tax benefits and yes, that money will compound for 30 or 40 years. But the most important reason to take advantage of retirement accounts is to get into the habit of investing — in other words: make it automatic. Nobody loves saving for retirement. It’s such a faraway goal, and it’s painful to say goodbye to money we have 10 uses for now. But chances are you’re going to live a long time and programs like social security – if it’s around at all — will make up an increasingly tiny portion of support you can count on when you’re older.
How do you balance saving for retirement with other savings goals?