Retirement planning: A step-by-step guide

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Retirement planning involves estimating how much money you'll need when you retire and then developing a strategy for saving and investing your money. There's no magic number, but the goal is to have enough income to live the life you want after you stop working.

If you're not sure how to start planning — or if you have been contributing money to retirement accounts and want to make the most of your savings — you're in the right place. This step-by-step guide will provide a roadmap on how to save for retirement.

Step. 1: Budget 15% of your pre-tax salary for retirement savings

A good guideline is to save at least 15% of your pre-tax income in a tax-advantaged retirement account. If your employer matches a portion of your retirement contributions, that contribution counts toward the 15%. This percentage isn't etched in stone, however, and you may need to adjust your savings rate based on your situation and your goals.

Even if you can't save 15% initially, you can work your way up to that level over time. The important thing is to get started no matter how small the amount you can afford to save.

The IRS sets annual limits on how much you can contribute to retirement accounts. You can contribute more money, known as catch-up contributions, when you're 50 or older.

Don't worry if you can't afford to contribute the maximum amounts. Focus instead on what you can afford. What's more, aiming to save 15% isn't appropriate for everyone.

You're getting a late start on saving for retirement.

In either scenario, you may need to save more aggressively because you have less time to benefit from compounding. Compounding happens when your investment earnings generate more earnings. This process expedites your investment growth over time, creating more earnings potential the longer you stay invested.

When you have less time to save, your money has less time to compound, so you may need to save more to reach your retirement goals.

You have high-interest debt, like a credit card balance: Credit card interest rates are substantially higher than the returns you can earn from your investment accounts in an average year. Paying down credit card debt first may save you more money than you'd typically earn from investing returns.

You don't have an emergency fund: Try to build a three-month fund that you keep in a high-yield savings account . If you don't have emergency savings , you could be forced to withdraw retirement funds if you lose your job or get sick. That can be costly because, barring special circumstances, you will likely owe taxes and a 10% penalty on early withdrawals before the age of 59½. The long-term impact is even worse when you consider the lost compounding opportunity. Your money has less time to grow when you withdraw from investments early.

Here's a breakdown of your retirement account options.

The most common type of employer-sponsored retirement plan is the 401(k). However, if you work for the government or a nonprofit, you may have another type of retirement plan, like a 403(b) or a 457(b) plan.

Many employers match a portion of employee contributions to these retirement accounts. For example, your company may match 50% of your contributions up to 6% of your salary. In this scenario, you'd contribute at least 6% to get the full match. If you contribute 6%, your employer contributes 3%, bringing your total contribution rate to 9%.

If your employer matches some of your contributions, make it a priority to get the entire match. Otherwise, you're passing up free money.

An IRA is a retirement account that isn't tied to an employer. You can open an IRA regardless of whether you have a workplace plan. You'll need income from working (like a salary, hourly wages, tips, commissions, or self-employment income) during the tax year to contribute.

IRAs have virtually unlimited investment options and usually have lower fees than 401(k)s. If you don't have access to a workplace plan or your employer doesn't match contributions, an IRA can be a good way to start saving. The downside is that annual IRA contribution limits are much lower than 401(k) limits.

There are several retirement plans available for self-employed people, such as a Simplified Employee Pension (SEP), SIMPLE IRA, and Solo 401(k).

IRAs are available as traditional or Roth accounts. Many workplace retirement plans also offer these two options. The difference boils down to how you're taxed and eligibility.

Contributions to traditional 401(k)s and traditional IRAs are made with pre-tax dollars, meaning that the money you deposit in these accounts will often lower your taxes for the current year. However, you will owe taxes once you begin taking your distributions in retirement.

Contributions to Roth 401(k)s and Roth IRAs are made with after-tax dollars. There's no upfront tax break, but if you wait until you're 59½ and you've had the account for five years, your distributions will be tax-free.

Both traditional and Roth retirement accounts defer annual taxes on your investment income. This is different from a taxable account, which requires you to pay taxes on interest, dividends, and realized capital gains in the year they are earned.

Roth IRAs also give you the flexibility to withdraw all of your contributions (but not the earnings) at any time without paying taxes or a penalty. This is best avoided, though, unless you're facing a financial crisis. Note that income limits apply to Roth IRAs, so you may not be eligible to contribute if your earnings are high.

No. 3: Decide how to prioritize contributions to retirement accounts

Once you've selected your retirement accounts, you'll have to decide how to allocate your money. Here's a good way to prioritize:

Strive to contribute enough to get your employer's match on your 401(k) contributions.

If you have extra money to save, aim to max out a Roth IRA, if you meet the income requirements, or a traditional IRA. If you don't qualify for an employer-sponsored plan with a match, start with the Roth IRA.

After you've maxed out available IRA contributions, use extra money to make unmatched 401(k) contributions. You could also invest extra money in a brokerage account. Taxable accounts don't qualify for tax-deferred earnings, but they don't have withdrawal restrictions either.

Your contributions then need to be invested. Many employer plans have a relatively limited number of investment options, which are usually mutual funds. One easy option is to go with a target-date fund, which bases your investments on your estimated retirement date. IRAs have much broader investment access. Depending on the account, you may be able to invest in individual stocks, funds, bonds, and even real estate.

Many brokerages offer robo-adviser services, which use algorithms to decide how to invest the money in your IRA.

Social Security is another important part of your retirement plan. To see an estimate of your future retirement benefit and verify that Social Security's record of your earnings is accurate, create a Social Security account at ssa.gov.

While you're at it, brush up on the basic Social Security rules:

You're eligible for 100% of your benefit at full retirement age, which is 67 if you were born in 1960 or later.

You can claim retirement benefits as early as 62, but you'll receive a reduced benefit.

You can hold out for a larger benefit until age 70, at which point your benefit maxes out.

Your benefit is based on your 35 highest-earning years.

When you're beginning your career, you may not have much money to save for retirement. Focus on getting your employer's 401(k) match when you're starting out. But make it your goal to save more as your income increases or you pay down debt.

Budgeting for future financial milestones can help you achieve this step. Try layering in a bit more savings whenever your income increases or you cut an expense. For example, you could decide to allocate 25% of your next pay bump to your retirement accounts. Or, once you pay off your credit card or car loan, put the money that went toward monthly payments into your 401(k) or IRA.

No. 6: Work with a financial advisor, as needed

Once you've been saving for a while, working with a financial advisor may be worthwhile. A financial adviser can evaluate your investing activities to determine if you're on track to meet your goals. Advisors can also project different scenarios to show you how saving more, investing differently, or changing your retirement timeline may be appropriate.

Questions to ask while retirement planning

Consider the following questions as part of your retirement planning process:

How much money should I contribute to retirement accounts?

When should I take Social Security benefits?

If these questions feel hard to answer now, don't worry, they'll get easier as you go through the process of retirement planning.

In the early stages, your goals may be vague. You may only know that you want to stop working someday, but you're not sure how, where, or when. That's enough information to help you focus on setting aside savings and investing that money appropriately — and that's true no matter how much money you're able to save.

As retirement draws closer, you'll be in a better position to make specific plans, such as deciding where you want to live, when you'll quit working, and when you'll start receiving Social Security benefits.

Retirement planning is personal, and the amount of money you need will depend on the factors listed above, along with some things you have less control over, including your healthcare needs and how long you live.

So, how much do you need? An often-cited piece of conventional wisdom indicates that you should plan to replace up to 80% of your pre-retirement income once you've retired. Other estimates say 70% or less.

Fidelity advises people save between 55% and 80% of their pre-retirement income to maintain their lifestyle, but that percentage can be as low as 45% if you're "saving 15% each year from age 25 to 67."

Recommendations like these can provide an estimate for planning purposes, but the actual amount you need to retire is personal to you and depends on many factors, including your lifestyle and where you want to live after you stop working. For example, if you live frugally and retire debt-free, you'll need less money than if you plan to travel extensively or own multiple residences.

You can earn your targeted retirement income from different sources. Common options include:

Distributions from retirement accounts, including a 401(k) and individual retirement account (IRA)

Investment income from dividends or real estate

Your investing efforts in your working years can fund a 401(k), IRA, real estate purchases, or a taxable brokerage account. Depending on your age and risk tolerance, investments you might consider for your retirement and taxable accounts include:

Individual company stocks: You can usually hold these in IRAs and taxable brokerage accounts.

Mutual funds and exchange-traded funds or ETFs: 401(k)s, IRAs, and taxable brokerage accounts generally have access to a range of funds, each with its own investment strategy.

Target-date funds: Target-date funds own a mix of different investment types, like stocks and bonds. These funds adjust their holdings so that your risk declines as you approach your retirement date. They are meant to be held alone as the only asset in your portfolio.

Target-risk funds: Target-risk funds also have different types of assets, but they maintain a consistent risk level over time.

REITs: REITs, or real estate investment trusts, are companies that own and manage real estate. They earn on rents and property appreciation.

Your targeted retirement age is another important consideration. Retiring early may be the dream, but it can strain your finances. When you retire early, you have less time to save, and you need more money.

The sooner you start planning and saving, the better your odds of achieving a comfortable retirement. Remember, every dollar counts. Even if you can only save a few hundred dollars initially, that money will have time to grow and benefit you down the road thanks to the power of compounding.

Expect your retirement goals to evolve. Your plans will probably be vague when you're in your 20s and 30s. But over time, you'll get a better sense of what your retirement needs will be.

For many people, retirement planning is a multi-decade process of preparing for the day when they no longer get a paycheck from their job. The earlier you start thinking about and planning for retirement, the more likely you are to have built up enough savings to live comfortably after you stop working. Even if you're already in your 50s and can set aside only a small amount periodically, it's important to remember that even small amounts help.

How much do you really need to save for retirement?

Figuring out how much you need to save for retirement can be tough, especially if it's still a long way off. These guidelines can help you determine the right amount.

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