Before graduating from college, I got my first professional job. I was hired on as a Resident Director the last semester in my senior year. It wasn’t a position that I knew I would apply for well in advance. Instead, I was sought out because of my previous years of working in Residential Life. I still vividly remember the day that I received the call from the Director of Residential Life. She called me up, literally minutes before I stepped on an airplane to go home for Christmas break. I was saying goodbye to my then-fiance and my phone started jingling.

Within a few minutes, she explained that the former Residence Hall Director was leaving and she wanted me to apply. I initially turned the offer down, but later changed my mind and was hired just a couple days later. I went through the official paperwork and for the first time in my life, had an opportunity to sign up for a retirement account. Being the typical 21-year-old that I was, I didn’t think twice; I turned it down. I preferred to have the cash. When I explained my reasoning to my soon to be father-in-law (which was something along the lines of, “I’m too young to save for retirement. I don’t need to start saving yet.”), I remember his response: “I’m not so sure...” While I wouldn’t say that these words have haunted me, I will admit that they helped me re-focus my priorities just a couple years later. Now 4 years wiser, my wife and I are aggressively saving for retirement. But, I can’t help but wonder if I am saving enough.

Challenges in Saving for Retirement as a Young Adult

As we all know, young adults face many financial challenges. This is no rare exception when it comes to retirement. In fact, there are quite a number of challenges that appear when it comes to young adults and retirement planning:

  1. Low Income – It’s no secret that employees typically earn their lowest salary when they are first starting out. I know this to be true for me and my wife, and it was even worse a couple years ago. This means that there is less money to draw from to designate for retirement. Despite how good of benefits you have, if you aren’t making that much money, you will be at a huge disadvantage when it comes to saving for retirement.
  2. Uncertainty of Future Growth/Returns/Inflation – Starting to save when you are in your early 20’s may be a good thing, but it is also hard to plan for retirement that may be 35-40 years away. How can anyone predict economic downturns or recessions like we have seen in the past 5 years? The simple answer is that you can’t – no one can. For this reason, it’s hard to predict what the market will do over the next 40 years. In the same way, it’s practically impossible to predict how inflation will affect the buying power of your money. Some years inflation may increase by 3%, but others it’s practically nothing.
  3. High Debt – Young adults also have another common feature: student loans. While I was able to graduate without any college debt, everyone else isn’t as lucky. Graduating with $30,000-40,000 (or more) in debt can wear on you. Not only that, but it limits your ability to contribute to your retirement accounts until that debt is paid off. If you try to balance debt payoff while saving for retirement, that means you’re paying off your debt longer, thereby affecting your ability to save for retirement longer.

Despite facing these common and challenging obstacles to saving for retirement, young adults can and must save for retirement. In fact, they must start asking how much they need to save for retirement.

Saving for Retirement

Paths to Save for Retirement

Because everyone’s situation is different, it is hard to suggest one cookie-cutter number that everyone should abide by. Instead, I thought I would illustrate three different ways to save for retirement and how it will change one’s ability to retire. For all examples, we are making a basic assumption that each investor receives a 7% annual return on his/her investments. While many investors will question the 7% estimate that I am using, this is close to the historical average. This is not to mention that I am using the same return rate for all three situations and the primary purpose is to compare the three – not to offer the exact amount of savings at retirement.

Average Joe

Average Joe is eligible for his 401(k) when he turns 25. He doesn’t see a huge rush to pad his retirement account with extra cash, but he is also smart enough to know not to give up free money. He invests up to the level to receive his employer’s match, meaning that each year, he is investing 4-7% in his retirement account. For simplicity purposes, we’ll say he is investing $4,000 each year. It’s not a lot of money, but it’s enough to make him feel good about himself when he compares himself to many of his peers still in grad school who don’t have a retirement account.

If Average Joe continues this contribution amount until age 60, with an average return of 7% on his investments, he will have almost $600,000 in his retirement account. This is no small amount. Yet, it is chump change when you calculate the amount that he can use each year without depleting his cash reserve before kicking the bucket. Using a safe withdrawal rate of 4%, that amazing $600k only provides Joe with $24,000. When you factor in taxes and inflation, Average Joe may be living in the poor house.

Motivated Mandy

Mandy has read enough personal finance blogs and books to know the importance of saving for retirement even at a young age. At 25, Mandy also starts saving for retirement. But, Mandy doesn’t joke around. In addition to using her employer’s 401(k) up to the match, like Average Joe, Mandy also invests $5,500 in a Roth IRA. This is the current max (for 2013) for this account. She is contributing over double the amount of Average Joe and it shows in her nest egg for retirement. Contributing $9,500 each and every year until age 60 will provide her approximately $1,400,000 to use for retirement. The save withdrawal rate of 4% provides her with approximately $57,000 in income. Just by saving $5,500 more each year, she has more than doubled her retirement income (without factoring in social security or any other income sources, of course).

Perfect Peter

Peter is the ideal retirement saver. He graduates from college and gets a job with a great salary. He doesn’t love his job, so he wants to do everything that he can to save for retirement. He maxes out his 401(k) at $17,500 each year and also maxes out his Roth IRA at $5,500. Between these two tax-advantaged retirement accounts, he invests $23,000 each and every year. He could save more in a taxable account if he wanted, but he prefers to keep it simple. At the age of 60, Perfect Peter has accumulated approximately 3.4 million in assets, or an annual retirement income of $137,000. This gives you an idea of what is possible if you max out your tax-advantaged accounts for 35 years. While he is investing a lot of money each year, it’s not impossible. Those who make close to 6 figures should be able to find a quarter of their income to invest for retirement.

If not already obvious, the more you invest, the more you drastically increase your retirement income. While it’s hard to predict how much more money you will have, the guaranteed result is that you will have more income in retirement. Let’s take a look at the estimates one more time.

Person Annual Contribution Retirement Savings Retirement Income (4%)
Average Joe 4,000 596,000 24,000
Motivated Mandy 9,500 1,400,000 57,000
Perfect Peter 23,000 3,425,000 137,000

I don’t know about you, but when I saw these numbers, I instantly felt like having enough to retire on was achievable. If you add in another income (with more contributions towards retirement) in the case of being a dual-income-no-kids family, saving for retirement becomes even easier. Too often, people talk about how it will be impossible to save enough. This just isn’t the case.

How to Approach Retirement: How Much do You Need to Save -vs- How Much Can You Save

Figuring out how much each person needs to save for retirement is a difficult question because there are a lot of factors that come into play. Because you don’t know what kind of returns you will get, the best approach is not to make it harder on yourself by saving too little. In fact, the basic question of asking how much is required to save in order to have enough presumes that you are trying to do as little as possible in order to get by.

I don’t know about you, but I don’t want to JUST get by when I am old and wrinkly.

Instead of trying to do as little as possible, try asking yourself how much you can save. Maximizing your savings each year offers you greater flexibility. It means that you can have a larger financial cushion as well as increased lifestyle flexibility. If you become physically unable to work at age 50, if you saved more money early on in your career, you may be able to think about early retirement.

If you are trying to figure out how much you should save for retirement, the simple answer is as much as possible. Start out by saving an amount that hurts a little. Then, as you get raises, use all of that income to increase your retirement contributions until you have your tax-advantaged accounts maxed out. You can never have too much money for retirement.

Readers, are you saving for retirement? How do you measure up to Joe, Mandy, and Peter?