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- My financial planning clients always want to know: How much do I really need to save every year?
- It all depends on your goals: Think about how and when you want to retire, for example.
- The more expensive your goals and the faster you want to achieve them, the higher your savings rate needs to be.
As a financial planner, also known as a CFP, I help many different types of people with their finances, and they all tend to have one major question in common: How much do I need to save each year?
Regardless of income, goals, relationship, or family status, everyone wants to know the "right" amount to save now in order to have enough in the future. And that makes sense, because we all need to save something.
So if you're wondering how much you need to save each year, try using this framework to focus in on an optimal answer for your situation.
What to consider when setting an annual savings goal
You have to know what your goals are before you can know how much you need to save. When considering a general amount to save each year, we're typically looking at long-term goals like retirement or financial independence.
The more aggressive your major financial goals — the more expensive they are, the faster you want to achieve them, the amount of individual goals you have — the more you need to save each year to fund them.
For example, the savings rate required for someone who wants to retire at 65 and pay for some but not all of their child's college education does not need to be as high as someone who wants to retire at 50, buy a vacation house, send their child to a private college and pay all costs, and travel extensively once they quit working.
Obviously, there is a lot of space between those two extremes. Consider where you may fall on the spectrum to get an idea of how much (or how little) is appropriate to save.
In that example above, the first person with modest goals may be perfectly fine to save 15% of their income each year. The second person, however, may need to save upwards of 40% of their earnings to build the assets required to fund everything they want.
You also want to choose a savings rate that, when combined with a reasonable and probable rate of return on that money, produces a consistent success rate later in life. In plain English, that means we want to save enough so that we don't have to rely on unrealistic expectations when it comes to investment returns.
The more you save, the lower the return you have to earn on your money to have your plan work. That's important, because it means you don't have to take as much risk to achieve the same goals.
But you also want to choose a savings rate that is realistic and sustainable, that you can commit to and stick with over time — because you're going to have to save and keep saving in order to reach success.
Finally, you want to consider what other sources of money you will have in the future once you stop working. For example:
- If you have a reliable inheritance that you expect to receive in your lifetime, you may not need to save as much (just don't completely rely on that to make your entire financial plan work — there are no guarantees!).
- If you have a lower income, you may receive more from Social Security. Social Security replaces more of your income when you are in lower earnings brackets. The more you earn, the more of your income you will have to replace yourself in your retirement.
- If you have a pension, you may be able to save a little less and still meet your goals.
Potential savings rates to consider
To help you narrow down into a specific range, consider the following:
If you're saving less than 10% of your income: Save more if possible! If you're building wealth from scratch and have a longer list of goals than "retire in my 70s," a savings rate under 10% year over year isn't sufficient to get you there.
There are exceptions to this. For example, you may be trying to grow your assets in a different way. Maybe you're starting a business and need to reinvest any profit back into that company to grow, or you just ran into a really tough year and need to focus on simply breaking even.
But in general, most of us need to save at least 10% (but probably much more) of our incomes each year in order to achieve the financial goals we have.
If you're saving 10 to 15% of your income: This is the baseline many experts recommend for a savings rate. It's a good starting point if you plan to follow the typical trajectory and retire between 65 and 67 (or even later). It's also a great place to be if you earn less than six figures.
However, it may not afford you a lot of flexibility in your retirement years, and you will most likely need to rely on additional income streams like Social Security to have enough to last through your lifetime.
If you earn six figures, you should probably aim to save a higher percentage of your income in order to make your long-term goals more achievable.
If you're saving 15 to 20% of your income: Saving at this level is likely where you start to see a little bit of flexibility in your future. This savings rate puts you on track for financial stability and enjoying a little more choice down the road (like retiring a few years earlier, or being able to pivot to a lower-paying but more satisfying job in the future).
If you're saving 20 to 25% of your income: You're on pace with the baseline my company recommends for our own financial planning clients. We find that, for households earning $250,000 or more, saving 25% of income is highly achievable and still leaves plenty of money in cash flow to use on enjoying life in the present moment.
The reason we like the 25% benchmark is because that's typically where we start seeing all kinds of different financial plans consistently show high probabilities of success. We like to err on the side of saving more rather than less to make sure clients will have plenty of wealth later in life to allow for financial freedom and choice rather than being restricted in any way.
If you can maintain this level of savings for many years, you not only build a good level of assets for the future, you also give yourself the flexibility to reduce that savings rate at some point in the future because the power of time in the market and compound interest starts having your money do the work for you.
If you're saving 25% or more of your income: This is a great place to be if you're serious about early retirement or financial freedom. The earlier you want to reach financial independence, the higher your savings rate should be. It's very likely that a rate of 40 to 50% — or more — is necessary to get you to your goal if you're targeting financial freedom in your 40s or 50s.
Stick with a savings rate (not a dollar amount)
Regardless of where you settle on your answer for "how much to save," make sure you set your target as a percentage of your income. Don't use dollar amounts.
By using a percentage (like 10%, or 25%, or 40% of your annual earnings), you keep your savings relative to your income. That means you don't necessarily need to change your savings target every single time your income fluctuates.
If you commit to consistently saving 20% of your income, then you can avoid lifestyle creep even when you get a raise; the dollar amount you save will naturally rise, because your savings goal will be 20% of your higher income.
On the flipside, if your income dips, the amount you need to save will decrease as well (which is reasonable when you're not earning as much money, and you have less available in your cash flow for everything you need to afford).
Keep in mind good financial planning is dynamic and changes over time. It's worth periodically reviewing your savings rate to determine if your targeted percentage is helping you stay on track to your goals, or if you need to make an adjustment.
We see this most often with clients who experience big jumps in income year over year; if that sounds like you, then you might consider increasing your targeted savings rate too to capture that potential financial power. The more you make, the easier it is to save large chunks of your earnings.
Saving is good — but don't stop there!
We tend to default to the word "savings" when we're having these conversations, but we need to be clear that "saving for the future" really means taking the money you set aside from your earnings and investing it.
Saving cash (like in a high-yield savings account) is a great idea for short-term goals that you need to fund in the next few months up to five years. After that point, though, it's worth considering if you should invest that money instead.
Letting cash sit around exposes your money to loss of purchasing power — especially if inflation continues to run rampant.
Investing, however, gives you the opportunity to earn returns. Keeping your money invested means those returns can earn their own returns, and that's how compounding can start working in your favor to grow wealth.
This article was originally published in November 2022.
