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How to tell if you’re on track

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Saving for retirement is one of the most challenging goals facing Americans. Many people don’t know the first thing about investing, yet they’re thrust into the position of money manager.

Don’t fret — it’s not as daunting as you might think. The important thing is to get started, no matter where you are in the scheme of things.

If you’re just beginning your career, you have a wonderful opportunity to capitalize on your youth. Don’t know the first thing about 401(k) or other company plans? Bankrate’s article, “Retirement accounts for newbies,” tells you how to get started. If you’re not sure how to invest, take some investing shortcuts until you amass a tidy sum.

Once you do that, you can build a portfolio that’s appropriate to your age, risk tolerance and goals. After you’ve accumulated some serious money, you can devise a more elaborate asset allocation strategy that includes a wide variety of different investments.

The ideal time to start is when you’re young, even if you’re juggling savings and debts, all of which compete for your money.

The difference 10 years can make
What’s the difference if you start your retirement savings at 25 versus waiting until age 35 to begin?

To illustrate, let’s imagine savvy Cindy signs up for her 401(k) plan as soon as she starts her new job at age 25. She’s able to sock away $3,000 each year for 10 years, and then she gets pregnant and leaves the work force.

Assuming she earns 8 percent a year on her investments, by age 35 she’ll have $43,460 saved up in her tax-deferred account. She decides she likes being a stay-at-home mom, so she stays out of the work force for several decades.

Meanwhile, tardy Marty (who likes to party) waits until age 35 to start saving for retirement. So he scrambles and begins saving $4,000 a year (a grand more than Cindy had saved each year). He’s the same age as Cindy; in fact they graduated from the same high school together.

Assuming his earnings grow at the same rate as those of Cindy, he’ll have $57,946 by the time he’s 45. At that age, Cindy’s investment will have grown to $93,826.

Marty continues saving $4,000 each year; by the time he reaches age 55, he has $183,048 saved up. Cindy has $202,564, and she still has not added any money to the account since age 35.

At age 65, Marty has amassed $453,133, about $16,000 more than Cindy’s nest egg of $437,320. But remember, Marty contributed $120,000 of his hard-earned money to reach this sum; Cindy’s outlay was only $30,000.

OK, the above illustration of Cindy and Marty’s savings is simplistic. Most people will save a percentage of their income each month rather than a lump sum once a year, plus it doesn’t take inflation into account. But this calculation serves to show the magic of compounding when it has an extra 10 years to work for you.

Note, though, that if Cindy were truly savvy, she would continue to save for retirement throughout her life, since women face more retirement challenges than men. In fact, a recent study by Hewitt Associates found that, on average, women should save 2 percent more of their annual pay than men to have the same standard of living in retirement. This helps to offset their lower earnings and longer lifespans.

How much do you need to save?
Let’s say you’ve been saving for retirement and you’re in the middle of your earning years. How are you doing? It’s hard to know offhand. You might want to enlist the services of a fee-based financial planner.

But if you want to get a quick idea, read on. A study that appeared last year in the Journal of Financial Planning provides a way to determine if you’re on track or if you need to step up your savings.

The study’s authors assume that you will need to replace 80 percent of your pre-retirement income, defined as gross salary minus the amount you’ve been saving for retirement. The reasoning: You won’t be saving for retirement once you’re retired. The authors also assume that pre-retirement earnings and post-retirement cash flow needs to grow in line with inflation at 2.5 percent annually, and that upon retirement, you will use the money to purchase inflation-indexed annuities that guarantee income for life.

Check out the table on the next page to find out what your current savings rate should be. For example, let’s say you’re 40 years old and you earn $60,000 a year. If you have not saved anything up to this point, your savings rate should begin immediately at 17.6 percent.

National savings rates
Age Income Savings rate Deduction for each $10,000
25 $20,000 5.8 percent 1.6 percent
25 $40,000 8.2 percent 0.78 percent
25 $60,000 10 percent 0.55 percent
25 $80,000 11.2 percent 0.4 percent
30 $20,000 7 percent 1.65 percent
30 $40,000 10 percent 0.79 percent
30 $60,000 11.8 percent 0.54 percent
30 $80,000 13.6 percent 0.42 percent
35 $20,000 8.6 percent 1.75 percent
35 $40,000 12.2 percent 0.86 percent
35 $60,000 14.6 percent 0.55 percent
35 $80,000 16.4 percent 0.43 percent
35 $100,000 17.6 percent 0.34 percent
40 $20,000 10.2 percent 1.67 percent
40 $40,000 14.8 percent 0.86 percent
40 $60,000 17.6 percent 0.57 percent
40 $80,000 19.8 percent 0.42 percent
40 $100,000 21.4 percent 0.35 percent
45 $20,000 12.4 percent 1.76 percent
45 $40,000 18 percent 0.9 percent
45 $60,000 21.4 percent 0.59 percent
45 $80,000 24 percent 0.45 percent
45 $100,000 26.2 percent 0.37 percent
45 $120,000 28.2 percent 0.31 percent
50 $20,000 15 percent 1.87 percent
50 $40,000 22 percent 0.97 percent
50 $60,000 26.2 percent 0.64 percent
50 $80,000 29.8 percent 0.48 percent
50 $100,000 32.2 percent 0.39 percent
50 $120,000 35 percent 0.33 percent
55 $20,000 18.6 percent 2.11 percent
55 $40,000 27.2 percent 1.04 percent
55 $60,000 32.6 percent 0.71 percent
55 $80,000 36.6 percent 0.53 percent
55 $100,000 40.2 percent 0.43 percent
55 $120,000 43.6 percent 0.36 percent
60 $20,000 23.8 percent 2.39 percent
60 $40,000 34.4 percent 1.23 percent
60 $60,000 41.2 percent 0.81 percent
60 $80,000 46.8 percent 0.61 percent
60 $100,000 51.4 percent 0.5 percent
60 $120,000 55.4 percent 0.41 percent

Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, April 2007, by Roger Ibbotson, Ph.D.; James Xiong, Ph.D., CFA; Robert P. Kreitler, CFP; Charles F. Kreitler; and Peng Chen, Ph.D., CFA, “National Savings Rate Guidelines for Individuals.” For more information on the Financial Planning Association, visit or call (800) 322-4237.

Crunching the numbers
Now let’s assume you’re 40 with an income of $60,000, and you did start saving at an earlier age. Right now you have $100,000 saved up. What should your savings be in that case?

Multiply 0.57 percent (the figure in the fourth column) by each $10,000 you have accumulated. That equals 5.7 percent (10 x 10,000 if you have $100,000 saved.) Next subtract the total (5.7 percent) from that 17.6 percent savings rate to get 11.9 percent.

This study takes Social Security income into account, which replaces a higher percentage of income for low-wage earners, and a lower percentage of income for high-wage earners. (To simplify their calculations, the authors assume that full benefits are available at age 65, but in reality, the study’s authors recommend that you wait until full retirement age to collect the full benefit.)

Of course, if your salary increases in the future, you’ll need to make adjustments. The numbers aren’t foolproof, but these rates have a 90 percent chance of success, say the authors. They ran each combination of age, income level and savings rates through 2,000 market scenarios in “Monte Carlo simulations” — altogether 72 million simulations — to get these numbers. The portfolios they used in their research resembled those of target-date funds, which become increasingly conservative as retirement draws near.

Notice that the savings rate trends upward as you get older. That’s why it’s easier to meet your retirement goals if you get an early start. But as the chart shows, it’s never too late to get started.

Written by
Barbara Whelehan
Contributing writer
Barbara Whelehan is a contributing writer for Bankrate. Barbara writes about a range of subjects, including homebuying, real estate, retirement, taxes and banking.