How to Save $1 Million for Retirement

Investing, Investing Data
How to Save $1 Million for Retirement

“Spend less, save more” is always on the list of popular New Year’s resolutions, but as with commitments to get fit or lose weight, we find it hard to follow through. Overall, only 8% of Americans successfully achieve their goals.

But you can save money, even $1 million for retirement, without necessarily spending less. It turns out you’re likely to stick to your goals if you save a portion of your future income, rather than cut into current spending. It can be that simple, especially if you start early in your career.

Invest in the future

This is the premise behind Save More Tomorrow, or SMarT, developed by behavioral economists Richard Thaler and Shlomo Benartzi. The strategy aims to help people increase savings rates for retirement (or other financial goals) by having them invest a portion of future raises.

The economists report that one group of workers who adopted the strategy saw their retirement savings rates go from 3.5% before receiving the advice to 13.6% four years later. About 80% of those employees stuck with the strategy throughout that whole time.

NerdWallet decided to put the strategy to the test by running some numbers for two hypothetical cases. In each, half of annual raises are invested (and all of a bonus, for those fortunate enough to get them). Our numbers are in addition to any other savings strategy.

A 25-year-old starting to save for retirement

Let’s take a hypothetical 25-year-old who makes $45,000 a year and expects to receive 3% annual pay raises until retirement at 65. If she saves and invests half of the raise portion of her salary each year, she can increase her savings rate without cutting into her current spending habits. If she earns an average annual return of 7.5%, this will turn into $223,924 by the time she is 65 (see our methodology below). This isn’t near recommended retirement savings rates, but it is one way to get closer to your financial goals.

Let’s assume our 25-year-old also receives an annual 5% bonus on her previous year’s salary. If she invests all of her bonus every year as well, her pretax savings at age 65 jumps to nearly $1 million.

In the chart below, use your cursor to follow the green or blue lines to see how saving and investing grows over time.

A 35-year-old saving for a child’s college

Our second example looks at a 35-year-old who is starting to save for his child’s college tuition in 18 years. He makes $55,000 a year, expects 3% annual raises, and plans to save 50% of the raise at a return of 6.5%. At these rates for 18 years, he’ll have saved $33,256 by the time his teenager arrives for orientation.

By investing 100% of bonuses every year as well (assuming a 5% bonus), he’ll accumulate $147,337 over 18 years. To put this in perspective, the College Board estimates that an average family pays a net of $12,360 a year at four-year, private colleges.

If tuition increases 5% a year for 18 years, annual college costs by the time the child enters college would be $29,746. Then, by the student’s fourth year, the annual cost would hit $34,434. However, our saver will be able to more than cover the entire cost of his child’s four-year degree with this plan.

In the chart below, use your cursor to follow the green or blue lines to see how saving and investing grows over time.

Making this strategy work

Use automatic deposit. Most investment platforms have features that automatically take money from your checking account, allowing you to set an investment strategy and manage your investing goals. Use our brokerage tool to figure out which investment platforms can help you start saving for retirement.

Choose the right account for your goal. Those working for an employer with a 401(k) plan should take full advantage of any employee match, and consider which retirement vehicles make the most sense for them. Once you’ve captured an employer match, you may want to begin funding an IRA. And if you’re saving for college, consider a 529 plan.

Apply this method to any sudden windfall. The SMarT strategy shows how investing little bits of money can add up quickly over time. To super-charge your savings, consider applying this strategy any time you come into extra cash. If you receive a tax refund, consider investing it. When you pay off a monthly debt — such as a car loan — direct those payments into an investment account instead.

So if you just received a pay raise, start developing your retirement savings plan now. Investing is a slow and steady process, but developing a plan like the SMarT strategy can help you reach your long-term financial goals.

Methodology

A 25-year-old starting to save for retirement

At the beginning of 2016, she got a 3% pay raise, from $43,689 to $45,000 a year (and expects similar pay raises until her planned retirement at 65). She begins a savings plan in which she invests 50% of her pay raise in a tax-deferred retirement account. In the first year, this is $655 annually, or $55 a month. In the second year, this is $675 annually, or $56 a month (50% of the $1,350 pay raise, from $45,000 to $46,350). If she continues at these rates, she’ll add $223,924 to her retirement portfolio.

A 35-year-old saving for a child’s college

He just received a 3% raise, from $53,398 to $55,000 (and expects similar pay raises through his career). He plans to save 50% of the raise ($801, or $67 a month, in the first year, and increasing thereafter) in a college savings account, like a 529, at an expected return of 6.5%. If he continues to save 50% of each annual raise for 18 years, he’ll have saved $33,256.

 Jonathan Todd is a data analyst at NerdWallet, a personal finance website. Email: jonathan.todd@nerdwallet.com.


Image via iStock.