6 Rules of Thumb for Retirement Savings, Explained

Tom Gilmour is a senior director of Planning Experience Integration for Northwestern Mutual.

While there’s no “magic number” everyone needs to save for retirement, there are some common rules of thumb to give you a target. Understanding the basics can help guide you as you create a target and work toward it.

So here are some important retirement savings guidelines to consider and talk over with an expert.

1. Aim to save 15 percent

Some consider 15 percent of your income the ideal benchmark, but if you’re just getting started or behind on retirement saving, then save as much as you can. That might mean starting small and increasing your contributions by 1 percent every year until you reach your goal.

Every contribution counts, especially over long time periods—thanks to compound interest. Basically, $1,000 saved today will typically be worth a lot more when you get to retirement than $1,000 saved 10 years from now. That’s because money invested today has more time to grow compared to money invested a decade from now.

2. Use the 25x rule

This guideline relies on spending rather than income. Sometimes called the 25x rule or the rule of 25, this savings target suggests putting away 25 times your current annual spending by the time you retire. For example, if you spend roughly $90,000 per year, the 25x rule would say you need about $2.25 million to retire comfortably. (That’s $90,000 x 25.) Consider it a broad estimation that takes future inflation into account.

After all, the length of your retirement is flexible and will be unique to you. The lifestyle you plan is a major factor—some people want to garden, while others plan to travel the world. So, you’ll want to consider additional factors like inflation, health care costs and taxes alongside your financial situation when making a retirement savings plan. Using the average 401(k) balance by age as a benchmark and talking with your financial advisor can help you stay on track.

3. Expect to spend 4 percent of your savings each year in retirement

For a long time, the 4 percent rule has been a popular guideline for retirement spending. It recommends withdrawing 4 percent of the total value of your savings during your first year as a retiree. You then withdraw the same amount every year afterward—adding enough to cover the current rate of inflation.

The 4 percent rule is designed to help retirees plan for longevity, but whether it works for you depends on considerations like your lifestyle, inflation, health care costs, taxes and market conditions. For example, the rule assumes your investment portfolio is split evenly between stocks and bonds during retirement.

The reverse 4 percent rule can help you gauge how much to have saved before you stop working. It starts with your expected annual expenses when you’re retired and divides that number by 4 percent. The result is your retirement savings target. Let’s say that after considering the money you’ll get from Social Security, you plan to need $60,000 per year in retirement. That would put your nest egg target at $1.5 million ($60,000 divided by 0.04). This becomes your savings goal.

4. Hold a greater percentage of bonds as you age

It’s important to also think about not just how much to save but where to save it. Revisiting your asset allocation (the way your money is divided between stocks, bonds and cash equivalents) regularly will ensure that your investment strategy matches your investing goals over time. One rule of thumb is to hold a greater percentage of stocks—which carry more risk—when you’re younger. This can position your portfolio for growth while you have time to recover from periodic market downturns.

But holding a greater share of bonds as you age can provide stability and help protect you from market volatility as you approach retirement. Here’s a look at what your portfolio might look like during different phases of your life.

The ideal asset allocation for you will depend on your unique retirement goals and how much risk you want to take on. Your financial advisor can ask questions to understand your values and goals to help you make the best decision. They may have you consider:

• Your mix of stocks and bonds and how to make those investments. Common account types include: Dedicated retirement accounts, such as a 401(k) or IRA.
• A Roth 401(k) or Roth IRA for different tax treatment.
• A regular brokerage account, giving you the freedom to invest and withdraw your money whenever you like—without restrictions or penalties.
• An annuity for a steady stream of income.
• Certificates of deposit (CDs), a type a savings account in which you can typically earn a higher interest rate in exchange for leaving your money in the account for a predetermined amount of time.
• High-yield savings accounts, which offer a higher interest rate, or annual percentage yield, than traditional savings accounts.
• A health savings account, or HSA (once you turn 65, you can use these funds for retirement income).

5. Have money in each corner of the tax triangle

Taxes have a big impact on retirement money, so this guideline focuses there. Your nest egg can be held in three main types of accounts. Together, this is commonly known as the “tax triangle.”

You may want to have some money in each corner of the triangle, which can prevent unwanted tax consequences as a retiree. For example, if the bulk of your money is in a 401(k), you could face a hefty tax bill each year in retirement.

6. No matter what, be consistent and stay diversified

Here’s a rule we can really get behind. The two most important retirement savings rules are to:

Make consistent contributions

Saving early and often is the best way to take advantage of compound interest. Some ways to help keep yourself consistent:

• Use automatic withdrawals from your paycheck so you aren’t tempted to spend the money.
  • Try to hit the annual contribution limits to secure the maximum benefits. (Once you’re 50 or older, you can contribute more to tax-advantaged retirement accounts.)
    • Put any windfall (like a large bonus or inheritance) toward retirement as an extra boost.

Stay diversified

Make sure that you don’t have all your eggs in one basket. Diversification is about investing in multiple asset classes to help reduce risk. Gains in one part of your portfolio could make up for losses in another. Diversification also includes investing in accounts that are taxed differently to help you mitigate your tax impact in retirement.

Your financial advisor can help

At the end of the day, these rules of thumb for retirement savings are only general benchmarks. The truth is that every situation is different. After all, the way you spend money may be very different than how even your close friends or siblings approach it. In a similar way, the amount you'll actually need to retire comfortably will depend on your retirement goals, desired lifestyle and how much you expect all of that to cost.

Your Northwestern Mutual financial advisor can help you create a plan that’s tailored to you. They’ll get to know what’s important to you and help you find opportunities and blind spots that may have otherwise gone overlooked. Together, you’ll develop a comprehensive plan to grow and protect your money—helping you to meet all of your goals now and in retirement.

All investments carry some level of risk, including loss of principal invested. No investment strategy can assure a profit and does not protect against loss in declining markets. This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.