Retirement: How much should you save?

Ask yourself these two questions before you decide how much you'll need when you retire.

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By Walter Updegrave, Money Magazine senior editor

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

NEW YORK (Money) -- Question: Should I contribute more to my 401(k) than I have to in order to get the company match? --Terry, Kennett, Missouri

Answer: At the risk of sounding wishy washy, it depends.

It depends, among other things, on your age, when you're hoping to retire, how much you already have saved, how large an income you want in retirement and how much of a cushion you want to give yourself against the possibility of a severe market downturn occurring just before you retire.

That said, there is a way for you to arrive at a reasonable estimate of how much you should contribute. To do that, however, I'm going to suggest that you ask yourself two questions. The first is how much should you be saving for retirement? And the second is in what type of accounts should you be doing that saving?

How much to save

For a ballpark figure of how much you should be saving on a regular basis, you can go to our What You Need To Save calculator. Just plug in your age, your income and how much you have socked away already, and you'll get an immediate estimate of the percentage of salary you should be saving.

You can take a more nuanced look at this question, however, by going to our Retirement Planner. Unlike the previous calculator which keeps things simple by making assumptions for you, our Retirement Planner allows you to pick your own set of assumptions -- retirement age, the percentage of pre-retirement salary you want to shoot for, your estimated Social Security benefits, how you'll invest whatever you save, etc. You can also see how altering your plan (saving more, investing differently, postponing retirement, etc.) might improve your prospects.

I want to be clear, though, that no tool or calculator can pinpoint the precise amount that you need to save for a comfortable retirement. There are just too many unforeseeable things that can happen over the course of a career. The markets might not deliver the returns you're expecting, you could find yourself laid off and unable to save for a while or you might have to dip into retirement savings to deal with an emergency.

But if you arrive at a reasonable estimate, adhere to that target as best you can and check your progress occasionally using a tool like the ones I mentioned above, you can at least know you're doing all you can to achieve a secure retirement.

Where to put your savings

Clearly, your 401(k) is the place to start. It's convenient, provides some nice tax advantages and your employer likely will match a portion of what you contribute, typically 50 cents on the dollar for the first 6% of salary.

So at the very least, you'll want to contribute as much as you can to get the full company match. If you do that and the combination of your contributions plus your employer's match results in a savings rate that, based on the estimates you got from the tools I mentioned, is enough to build an adequate nest egg, you could stop there (although, frankly, I doubt this will be the case for most people).

If, however, you need to save more -- or you can afford to save more and would like to give yourself a margin for error, or to live it up a bit in retirement -- you've got two basic choices.

The first is to just keep pumping as much money as you can into your 401(k). Under federal law, you can contribute up to $16,500 this year, plus another $5,500 if you're 50 or older, although your plan can set a lower ceiling.

The advantage to this approach is simplicity. Your contribution is automatically deducted from your paycheck, so you're assured it'll go right your account. There's less chance for "leakage" -- i.e., spending the money before you get a chance to save it.

If you max out your 401(k) and you still want to save more, you can then check out other tax-advantaged savings options, such as a regular IRA or a Roth IRA, both of which allow you to contribute up to $5,000 (plus another $1,000, if you're 50 or older), assuming you're eligible.

And if you need or want to save even more, you can always do so in taxable accounts. You won't get the same advantages as with a 401(k) or IRA. But depending on which types of investments you choose and how much effort you want to put into it, you may still be able to get some tax benefits.

The second way to go starts out much the same as the first approach, but then differs in one important way.

Instead of maxing out your 401(k) and then moving to IRAs and other investments, you follow this strategy: contribute enough to your 401(k) to get the full employer match, then contribute as much as you can to a Roth IRA. If you can afford to save even more, continue funding your 401(k) to the max and, if you have still more bucks to save, move on to taxable accounts.

In short, the idea behind this approach is to assure that you get at least some of your savings into a Roth IRA.

Which is the better way to go? Sorry to get back to that phrase again, but it depends. I like the idea of having at least some money in a Roth account because a Roth's tax-free withdrawals allow you to hedge against the possibility of higher tax rates in the future and give you more flexibility for managing your tax bill once you retire.

On the other hand, I'd hate to see someone pare back his or her 401(k) contributions with the intention of contributing to a Roth IRA, and then never getting around to it.

Bottom line: If a Roth IRA makes sense for you, you're eligible to do one and you have the discipline to follow through with the contribution, then I'd say follow the second approach.

But if you're not a good candidate for a Roth or don't qualify for one, or you can't trust yourself to save on your own, then I'd say follow the first approach.

Either way, your first priority is to make sure you're saving enough. Because if you don't do that, you're going to come up short in retirement no matter which accounts you underfund now. To top of page

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