3 A’s of Successful Saving
No one needs to tell you that you need to save for your future—hopefully, you're already doing it. After all, no matter your age and how far away retirement is, you want to be able to enjoy retirement
It's important to focus on 3 main things during your working years: the amount you save, the accounts you save in, and your asset mix. Of the 3, of course, the first is the most important, as no account or asset mix can make up for not saving enough.
1. Amount: How much and how long
We suggest starting as early as possible and consider saving at least 15% of pre-tax income each year toward retirement to help ensure enough in savings to maintain your current lifestyle in retirement.
The good news: That 15% savings rate includes any matching or profit sharing contributions from your employer to your 401(k) or other workplace savings account, like a 403(b) or governmental 457(b) plan. An employer match can make saving 15% easier. For example, Elaine earns $50,000 a year and her employer match is 100%, up to 6% of pay, which means her employer will match her contributions dollar for dollar, up to 6% of her salary. To save 15% of her salary for the year, or $7,500, she would need to contribute only 9%, or $4,500. Her employer would be contributing $3,000, or 6%, for her.
Of course, the longer you wait to start saving, the more important it is to take advantage of every opportunity to contribute the maximum to your 401(k).
In 2023, you can contribute up to $22,500 pre-tax to your 401(k). If you're at least age 50 at the end of the calendar year, you can add a catch-up contribution of $7,500 pre-tax.
In 2023, the annual contribution limit for IRAs, including Roth and traditional IRAs, is $6,500. If you're age 50 or older, you can contribute an additional $1,000 annually.
Health savings accounts (HSAs) are another type of tax-advantaged account. To open an HSA, you need to be enrolled in an HSA-eligible high deductible health plan (HDHP).
For 2023, the IRS contribution limits for HSAs are $3,850 for individual coverage and $7,750 for family coverage.
If you're 55 or older during the tax year, you may be able to make a catch-up contribution, up to $1,000 per year. Your spouse, if age 55 or older, could also make a catch-up contribution, but will need to open their own HSA.
Even if you can't contribute 15% of your income right now, try to contribute enough to get the entire employer match in a workplace account, which is effectively "free" money, and then try to step up your savings as soon as you can.
2. Account: Where you save
Be sure to make the most of retirement savings accounts like 401(k)s, 403(b)s, and IRAs. If you have an HDHP, consider taking advantage of health savings accounts (HSAs), which can offer one of the most effective means of saving for qualified medical expenses now and in retirement. Depending on the type of account, your contributions can grow tax-deferred or tax-free.
With a traditional 401(k) or IRA, your contributions are pre-tax, which means that they generally reduce your taxable income and, in turn, lower your tax bill in the year you make them. Your contributions won't avoid taxes entirely; you'll pay income taxes on any money you withdraw from your traditional 401(k) or IRA in retirement.
A Roth 401(k) or IRA works the opposite way. Contributions are made after-tax, with money that has already been taxed, and you generally don't have to pay taxes when you withdraw from your Roth 401(k) or Roth IRA.1
So how does a person determine which type of 401(k) or IRA to contribute to: a traditional or Roth account? There are several things to consider, but for many, the answer comes down to a simple question: Am I better off paying taxes now or later? For those who expect their tax rate in retirement to be higher than their current rate, tax-free withdrawals from a Roth 401(k) or IRA might be a better choice. On the other hand, for those who expect their tax rate to go down in retirement, a traditional 401(k) or traditional IRA may make more sense.
For those who can, it may make sense to contribute to both a traditional and a Roth account. That can provide the flexibility of taxable and tax-free options when it comes time to take withdrawals in retirement, which can help manage taxes. Those who aren't sure of their future tax picture could choose to make both types of contributions.
It's important to note that if you get an employer match or profit-sharing contribution from your employer, those contributions are always to a traditional 401(k), even if you are making only Roth 401(k) contributions. So you may already be contributing to both types of accounts.
Alternative saving options to consider:
If you're self-employed or a small-business owner, then small-business retirement plans like a self-employed 401(k) or SIMPLE or SEP IRA allow you to set aside a certain percentage of your income.
You may be able to contribute to an IRA even if you aren't working. As long as one spouse works, the non-working spouse can have a spousal IRA and contribute to their own traditional IRA or Roth IRA. You must file a joint federal income tax return. Spousal IRAs are also eligible for catch-up contributions.
If you have an HSA-eligible health plan, money contributed to an HSA is tax-deductible.2 And withdrawals for qualified medical expenses—now or in the future—are tax-free (that includes the money contributed as well as any earnings).
The cost of health care in retirement will likely continue to increase, so it can be a good idea to prepare specifically for those expenses.
According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2022 may need approximately $315,000 saved (after tax) to cover health care expenses in retirement.3
Saving in an HSA can reduce the amount you need because contributions, earnings, and withdrawals are tax-free when used to pay for qualified medical expenses.
If you have an HSA, consider contributing money above and beyond the amount you think you’ll need for the current year's health care expenses. If you're able to invest some of it for the future, you may have some of your future health care expenses covered.
3. Asset mix: How you invest
Stocks have historically outperformed bonds and cash over the long term. So when investing for a goal like retirement that is years away, it can make sense to have more invested in stocks and stock mutual funds. But higher volatility also comes with investing in stocks, so you need to be comfortable with the risks.
We believe that an appropriate mix of investments should be based on your time horizon, financial situation, and tolerance for risk. As a general rule, investors with a longer investment horizon should have a significant, broadly diversified exposure to stocks.
Take a look at our 4 investment mixes4 (see chart) and how they performed historically over a long period of time. As the chart illustrates, the conservative mix has historically provided much less growth than a mix with more stocks, but less volatility too. Having a significant exposure to stocks that’s appropriate for your investing time frame may help grow savings.
Data source: Fidelity Investments and Morningstar Inc, 2022 (1926-2022). Past performance is no guarantee of future results. Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes only. It is not possible to invest directly in an index. Time periods for best and worst returns are based on calendar year. For information on the indexes used to construct this table, see Data Source in the footnotes below. The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet an investor’s goals. You should choose your own investments based on your particular objectives and situation. Be sure to review your decisions periodically to make sure they are still consistent with your goals.
Think ahead
When retirement is years away and you have many other financial demands, it may be hard to focus on the future, but saving for retirement with the 3 A's in mind can help.
Important Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
LPL Financial does not provide legal or tax advice, and the information provided is general in nature and should not be considered legal or tax advice. Consult an attorney, tax professional, or other advisor regarding your specific legal or tax situation..
1. A distribution from a Roth 401(k) is tax free and penalty free, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, or death. A distribution from a Roth IRA is tax free and penalty free provided that the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, qualified first-time home purchase, disability.
2. Contributions to an HSA are federally tax-deductible and deductible in almost all states.
A Health Savings Account (HSA) is a tax-advantaged trust or custodial account used in conjunction with a high-deductible health plan (HDHP) which eligible individuals may establish to pay for current and future qualified medical expenses. Health Savings Accounts were created under the Medicare Prescription Drug, Improvement and Modernization Act of 2003.
3. Estimate based on a hypothetical opposite-sex couple retiring in 2022, 65-years-old, with life expectancies that align with Society of Actuaries' RP-2014 Healthy Annuitant rates projected with Mortality Improvements Scale MP-2020 as of 2022. Actual assets needed may be more or less depending on actual health status, area of residence, and longevity. Estimate is net of taxes. The Fidelity Retiree Health Care Cost Estimate assumes individuals do not have employer-provided retiree health care coverage, but do qualify for the federal government’s insurance program, Original Medicare. The calculation takes into account cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by Original Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services and long-term care.
4. Data Source: Fidelity Investments and Morningstar Inc. Hypothetical value of assets held in untaxed portfolios invested in US stocks, foreign stocks, bonds, or short-term investments. Historical returns and volatility of the stock, bond, and short-term asset classes are based on the historical performance data of various unmanaged indexes from 1926 through the latest year-end data available from Morningstar. Domestic stocks represented by IA SBBI US Large Stock TR USD Ext Jan 1926-Jan 1987, then by Dow Jones US Total Market data starting Feb 1987 to Present. Foreign stocks represented by IA SBBI US Large Stock TR USD Ext Jan 1926–Dec 1969, MSCI EAFE Jan 1970-Nov 2000, then MSCI ACWI Ex USA GR USD Dec 2000 to Present. Bonds represented by US Intermediate-Term Government Bond Index Jan 1926–Dec 1975, then Barclays Aggregate Bond Jan 1976 - Present. Short-term/cash represented by 30-day US Treasury bills beginning in Jan 1926 to Present. Past performance is no guarantee of future results. The purpose of the target asset mixes is to show how target asset mixes may be created with different risk and return characteristics to help meet an investor's goals. You should choose your own investments based on your particular objectives and situation. Be sure to review your decisions periodically to make sure they are still consistent with your goals.
Indexes are unmanaged. It is not possible to invest directly in an index.
LPL Financial does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. LPL Financial cannot guarantee that the information herein is accurate, complete, or timely. LPL Financial makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
Past performance is no guarantee of future results.
Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.