Start Saving Now
If you are 35 and starting from scratch, for example, you need to save around $735 per month to have $1 million by age 65, assuming an 8 percent average annual return. If you are 40, you need to save around $1,135 per month. If you were willing to take on more risk with your investments and managed to average a 10 percent annual return, you would only have to save around $506 per month from age 35, or around $850 each month from age 40. If you were more conservative, you would need to save more. You get the idea. (You can use the SEC’s calculator to plug in your age and determine monthly contributions.)
Keep in mind that these numbers do not take potential investment costs into account like management fees and fund expense ratios, which could decrease your annual returns by more than 2 percent. This means that you will likely need to contribute more and/or take on more risk to meet your goal. They also don’t take into account inflation and taxes (we’ll get to that in a minute).
Max Out Your Retirement Accounts
So, where is the best place to save this money for retirement? In tax-advantaged retirement accounts, of course! We’re talking about your 401(k), 403(b), traditional IRA and/or Roth IRA. These kinds of accounts allow you to avoid paying taxes on market growth (capital gains), which really makes a big difference in how much you can accumulate over the long run.
If your company has a plan available, the easiest thing to do is to save there through automatic payroll deductions. These types of plans have a 2018 contribution limit of $18,500 or $24,500 if you are over 50. In 2019, the individual limit changes to $19,000. If your company offers a matching contribution (a.k.a free money), you definitely want to put in at least as much as they will match.
If you have maxed out contributions to your company plan and still want to save more, you can put an additional total of $5,500 (or $6,500 if you are over 50) for 2018 ($6,000 in 2019) in a traditional or Roth IRA. Remember that Roth IRAs — unlike their traditional counterparts — allow you to grow post-tax money that you can potentially pull out totally tax-free in retirement.
If you do not have a company plan available and are an entrepreneur, or even if you do have a company plan but also freelance part-time, you may be able to open a SEP IRA or Individual 401(k), two other types of traditional IRAs. These plans allow you to save as much as $55,000 on a tax-deferred basis, including any other potential savings in other retirement accounts.
Don’t Forget About Taxes and Inflation
It’s also important to remember that, while hitting that seven-figure mark is still a major milestone, $1 million today won’t be worth that much in 25 years. Assuming an average inflation rate of 3 percent, it would only be worth around $475,000 in 25 years. (The average annual inflation rate has remained below 3 percent in every year since 2012.)
If you want an inflation and tax-adjusted balance of $1 million by age 65, you may need to save upward of $2,600 per month from age 35, or $3,200 per month from age 40, assuming an 8 percent return, and not including investment fees or state taxes. (We know: GULP.) Of course, that’s also assuming that you’re starting from scratch and accounting for 3 percent annual inflation. (You can do your own calculations with Bankrate’s inflation calculator tool.)
We know that may seem daunting; most people aren’t in a position to save $2,600 or more per month. But it does highlight the importance of starting early, or retiring a little later, in order to reach your retirement savings goal. Hopefully, you don’t have to start from scratch and you can build upon some base savings. You will help yourself a lot by saving extra cash (e.g. bonuses, tax refunds, inheritances) in tax-advantaged retirement accounts whenever possible, opening no or low-fee IRAs at a discount brokerage firm, and choosing lower-cost investments like indexed mutual funds and exchange-traded funds. Whatever your goal, the most important step you can take is to start saving anything you can now so your money can start growing and you’ll be that much closer to reaching $1 million, or whatever your personal retirement savings goal may be.