If the amount of money you’re saving each month doesn’t hurt, you are NOT saving enough. Remember this savings mantra as you look to achieve financial independence and finally be free to do whatever your heart desires.
Given everybody’s income and expenses are different, what’s most important is your expense coverage ratio. In other words, how many years (or months) of expenses can your savings cover in case your income goes to zero? Given nobody can work forever, we must increase our expense coverage ratio the older we get because we will have less ability and desire to earn in our advanced ages. At this point, it’s time to start drawing down our savings.
Financial Samurai Pre and Post Tax Savings Guide
First of all, everybody should be maxing out their 401k. For 2019, the maximum you can contribute is $19,000. The contribution maximum should go up $500 every year or so. Here is my 401k savings guide by age, depending on when you started working and contributing and investment returns.
At age 30 you should have saved between $100,000 – $300,000
At age 40 you should have saved between $250,000 – $1,000,000
At age 50 you should have saved between $600,000 – $2,250,000
At age 60 you should have saved between $1,000,000 – $5,000,000
Recommended After Tax Savings By Age
Now that you’ve got your pre-tax retirement savings out of the way, you should now have enough after-tax savings to cover your expenses.
The below chart is an expense coverage ratio chart that follows someone along a normal path of post college graduation until the typical retirement age of 62-67. I assume a 20-35% consistent after tax savings rate after contributing to a 401k for 40+ years with a 0-2% yearly increase in principal due to inflation.
The other assumption is that the saver never loses money given the FDIC insures singles for $250,000 and couples for $500,000. Once you breach those amounts, it’s only logical to open up another savings account to get another $250,000-$500,000 FDIC guarantee.
Expense Coverage Ratio = Savings / Annual Expenses
Note: Focus on the ratios, not the absolute dollar amount based on a $65,000 annual income. Take the expense coverage ratio and multiply by your current gross income to get an idea of how much you should have saved.
Your 20s: You’re in the accumulation phase of your life. You’re looking for a good job that will hopefully pay you a reasonable salary. Not everybody is going to find their dream job right away. In fact, most of you will likely switch jobs several times before settling on something more meaningful. Maybe you are in debt from student loans or a fancy car. Whatever the case, never forget to save at least 10-25% of your after tax, after 401k contribution income while working and paying off your debt. Shoot to have up to 1.5X your expenses covered in savings.
Your 30s: You’re still in the accumulation phase, but hopefully you’ve found what you want to do for a living. Perhaps grad school took you out of the workforce for 1-2 years, or perhaps you got married and want to stay at home. Whatever the case may be, by the time you are 31, you need to have at least one years worth of living expenses covered. If you’ve saved 25% of your after tax income for four years, you will reach one year of coverage. If you saved 50% of your after tax income a year for five years, you will have reached five years of coverage and so forth. You should have 1X – 6X your expenses covered in savings.
Your 40s: You’re beginning to tire of doing the same old thing. Your soul is itching to take a leap of faith. But wait, you’ve got dependents counting on you to bring home the bacon! What are you going to do? The fact that you’ve accumulated 3-10X worth of living expenses in your 40’s means that you are coming ever close to being financially free. You’ve hopefully built up some passive income streams a long the way, and your capital accumulation of 3-10X your annual expenses is also spitting out some income. You should have 4X – 10X your expenses covered in savings.
Your 50s: You’ve accumulated 7-13X your annual living expenses as you can see the light at the end of the traditional retirement tunnel! After going through your mid-life crisis of buying a Porsche 911 or 100 pairs of Manolo’s, you’re back on track to save more than ever before! You are 100% in tune with your spending habits, therefore, you raise your savings rate by another 10% to supercharge your final lap.
Your 60s: Congrats! You’ve accumulated 10-20X+ your annual living expenses and no longer have to work! Maybe your knees don’t work either, but that’s another matter! Your nut has grown large enough where it’s providing you hundreds, if not thousands of dollars of income from interest or dividends each month. Full Social Security benefits kick in at age 70 now (from 67), but that’s OK, since you never expected it to be there when you retired. You’re also living debt free since you no longer have a mortgage. Social Security is a bonus of an extra $1,500 a month. You’re budgeting a couple thousand a month for health care as you plan to live until 100.
Save And Save Some More!
The only way to reach financial independence is if you save and learn to live within your means. National average money market accounts are yielding a pitiful 0.1%. In fact, I keep about 90% of my saving in online CDs and savings accounts to prevent me from having the temptation to spend.
Thanks to the Fed’s aggressive and consistent rise in interest rates since 2015, you can get a healthy 2.45% in an online money market account with CIT Bank, for example. This is a fantastic return given what a huge run up in real estate and stock prices we’ve had.
Depositing and withdrawing money is easy, and the interest rate is obviously way higher than a bricks and mortar money market account. The other great reason to keep money in an online savings account is to protect yourself from your temptation to spend.
For the money you are comfortable risking, actively invest the rest of your after-tax savings in real estate, the stock market, bonds, private equity and anything else that matches your risk tolerance. The point is to gradually expand your savings into investments where you feel most comfortable. Many people, including myself, love real estate because we can see what we are buying.
It’s important to then track your investments to make sure you’re comfortable with your positions. I highly recommend signing up for Personal Capital, a free online wealth management tool that let’s you easily monitor your finances. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into one place to see how my stock accounts, how my net worth is progressing, and whether my spending is within budget.
One of their best features is their 401K Fee Analyzer which is now saving me more than $1,700 in portfolio fees I had no idea I was paying. They also have a fantastic Investment Checkup feature that screens your portfolios for risk.
Finally, they came out with their incredible Retirement Planning Calculator that uses your linked accounts to run a Monte Carlo simulation to figure out your financial future. You can input various income and expense variables to see the outcomes. Definitely check to see how your finances are shaping up as it’s free.
For those who are really motivated, the estate tax threshold rises to $11.4 million per individual, $22.8 million per married couple. The time to make your fortune is during a bull market when tax incentives are the greatest. That said, we’re almost 10 years into a bull market. Be diligent about saving and tracking your finances. You never really know when the bad times will return as the yield curve starts to flatten.