Dave Ramsey’s Step #4 is simply this–save 15% of your gross income for retirement, preferably in Roth 401(k) and Roth IRA retirement accounts. This step raises two important questions. First, what’s so special about 15% as opposed to 10%, 20% or some other savings rate? And second, why invest in after-tax Roth retirement accounts rather than pre-tax 401(k)s and IRAs?

To answer these questions, I’ve created some charts to show the impact of these decisions on your retirement nest egg. Following the charts, I’ll list some of the factors worth considering as you make your own retirement savings decisions.

## Save 15% of Gross Income Toward Retirement

Albert Einstein is said to have quipped, “compound interest is the most powerful force in the universe.” Whether he actually said this is undetermined. But to this I would add, “compound interest is *definitely* the most powerful force in a retirement account.”

To unleash this force you need two things: savings and time. The more savings and time you have, the more powerful the effect of compound interest. So what does the effect of compound interest have on saving 15% of your gross income?

### A 15% Savings Rate Example

Check out this chart showing the growth of 15% savings on a $100,000 per year salary. I’ve assumed a 10% return, 3.1% inflation, and savings beginning at age 30:

There are several important observations to make here. First, the ending balance of just over $2 million is in today’s dollars assuming a 3.1% inflation rate. The actual retirement savings balance after 35 years is over $6 million.

Second, notice that the chart is broken into three colors: yellow, blue, and purple. The yellow represents the actual amount of money invested. The blue represents the amount earned directly from the money invested (called simple interest). And the purple represents the amount earned from the simple interest (called compound interest). All of these numbers are adjusted for inflation.

Here’s the key point: Given enough time, the compound interest earned will far exceed the amount invested or even the simple interest. That’s the most powerful force in the known universe that Einstein was talking about!

Finally, note that the $2 million balance in today’s dollars is enough to withdraw about $80,000 a year for retirement. That’s exactly what you’d need if you were seeking to replace 80% of your income in today’s dollars. (I’ve written before about the 4% withdraw rate rule for retirement accounts.)

### A 10% Savings Rate Example

Now let’s see what happens if instead of saving 15%, you save 10%. Here’s the chart:

Notice that you still get the benefit of compounding. That’s because the benefits of compounding depend on how long you invest and what return you earn. But of course, the more you invest, the more you end up with.

In this case, at a 10% savings rate, you end up with about $1.3 million in today’s dollars. This is not enough to withdraw an amount equal to 80% of your pre-retirement income.

You may get Social Security benefits to make up some of this shortfall. But Dave Ramsey’s view is we shouldn’t count on Social Security. While I’m not as pessimistic on this point, ignoring Social Security in your retirement assumptions is certainly a conservative approach.

### How to Decide

From this, we can conclude that a 15% savings rate for retirement is a reasonable approach, given all of the assumptions we’ve made. In making your own decision on retirement savings, you may want to consider these additional factors:

**When you start saving for retirement**: If you start saving for retirement at age 18, you may not need to save 15% (although it’s a good habit anyway). At age 18, you have 47 years to invest before you’re 65. At a 10% savings rate using the numbers above, your inflation-adjusted balance at age 65 is more than $3 million (more than $13 million in actual dollars!).

If you wait until you’re 40 to begin, you may need to save considerably more than 15%. At that age, a savings rate of 15% yields less than $1 million in inflation-adjusted dollars. Even a 20% savings rate results in just under $1.3 million. So when it comes to retirement savings, one of the most critical success factors is to start saving as soon as you can. I should add that if you are in your 40s or older and have little retirement savings, there’s no point in beating yourself up over it. Just start saving now.

**Assuming a 10% return is generous**: The above calculations assume a 10% return on investments. Change it to just 9.5%, and the numbers drop considerably. Many believe that annual returns of 10% will be unrealistic in years to come. If you’re looking for predictions, you’ve come to the wrong place.

But I can say that sticking your money in a money market or “safe” bond account won’t get you the returns most of us need for retirement. I’ve written extensively about asset allocation. In addition, here are two great books that have helped me a lot in formulating my investment plan: *The Bogleheads’ Guide to Investing* (don’t let the goofy title of the book fool you, it’s a very good guide to investing) and *All About Asset Allocation*.

**Making your own calculations**: You may want to make your own calculations for retirement using assumptions that are different than what I’ve used. If so, here is the investment calculator I used in this article.

## Invest Retirement Savings in Roth Accounts

I believe that for most people most of the time, Roth retirement accounts are best. Why? Well, let’s first look at the numbers.

As with the above calculations, let’s assume you start saving at age 30, retire at 65, and invest $15,000 annually for retirement. We’ll also assume you are in the 25% tax bracket and (this is important) will be in the 25% tax bracket during retirement. Under these circumstances, which is best, a $15,000 investment in a Roth 401(k) or a traditional 401(k)?

The Roth 401(k) beats the traditional 401(k). But this test is unfair. Investing in the Roth 401(k) costs us more because we don’t get an immediate tax break like we do with a traditional 401(k).

So let’s further assume that we invest the tax savings we enjoy with a traditional 401(k) into a taxable investment account. Now which is best?

The traditional 401(k) balance improves, but it still doesn’t catch the Roth 401(k) balance. Why? It doesn’t catch the Roth 401(k) balance because the after-tax money invested in taxable accounts doesn’t grow tax-free like the Roth 401(k) does.

The difference in these two account balances represents the taxes you pay on the earnings from your taxable account. If you could invest the tax savings from the traditional 401(k) into a Roth IRA, the two account balances would be identical.

Now, what if your tax rate goes down during retirement? Here is a chart assuming a 25% tax rate during your working years and a 15% tax rate during retirement:

The balances get closer, but the Roth still edges out the traditional 401(k). Why? Again, it goes back to the fact that the tax savings from the traditional 401(k) are invested in a taxable account, where taxes must be paid on all earnings.

If your tax rate goes up during retirement, the choice in favor of a Roth 401(k) becomes even more clear. If you’d like to play with these numbers and assumptions yourself, here is the Roth 401(k) versus Traditional 401(k) calculator that I use.

Now, let’s put aside the numbers for a moment and consider some additional factors that are important to this decision:

**Future tax rates are unknown**: We don’t know what the tax rates will be a year from now, let alone 30 years from now. Many argue that they have only one way to go–up. Maybe, although the government can increase taxes without increasing the income tax rate. For my retirement investing decisions, I make no assumptions about future tax rates. How then, you may ask, do I make a decision between Roth and traditional retirement accounts?**You can pick both**: I invest in both Roth and traditional retirement accounts. Like so much in life, this is not an all or nothing choice. Since I don’t know where tax rates will go, I invest in both. My employer matches 401(k) contributions, and these matches must go into a traditional 401(k). Thus, I’ve started increasing the portion of my contribution that goes to a Roth 401(k). My goal is to direct 100% of my contributions to my designated Roth 401(k), while the matching contributions go to a traditional 401(k).**Roth accounts bring certainty to retirement planning**: One of the things I like about Roth accounts is that you know exactly what you have saved for retirement. With traditional retirement accounts, you have to make a guesstimate about taxes to know how much money you have to fund your retirement.**Conversion to Roth IRAs**: Roth 401(k) retirement accounts can be converted to Roth IRAs without any tax liability. I like this feature because Roth IRAs offer a distinct advantage over deductible IRAs and 401(k)s–no required minimum distribution during retirement. You can hold onto your Roth IRA for as long as want. It is a great way to pass on wealth to your children or grandchildren if that’s one of your goals. If you’d like to read more about this feature of retirement accounts, here are two books I own that are very good on the subject of taking your money out of retirement accounts:*The Retirement Savings Time Bomb . . . and How to Defuse It: A Five-Step Action Plan for Protecting Your IRAs, 401(k)s, and Other Retirement Plans from Near Annihilation by the Taxman*and*IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out*.

**NEXT–>**See the best (and free) online tool to track your investments

**Topics:**Retirement Planning

I have a pension plan through my university that requires I put in 7% of my income while the university kicks in 10% of my income. Do I really need to go up to 15% of my own income? That would mean I am saving 25% a year – seems excessive to me. All my money is fully vested and I have also vested my medical plan so I will have that for life without paying any additional premiums. I work for a state university and also have a guaranteed pension at age 55 from my other government service that I intend to use for paying for my kids’ college and then use it to pay off the house after that. Should be debt free (including the house at 60 with $1.2 million in savings and plan to work until 70. Between 60 and 70, I will have extra free cash flow of $25k/year after taxes from the house being paid off plus $10k from the other government pension – all extra money. Do I really need to cut expenses more to save more now? I am 50 with $100,000 in annual income and take-home $5,000 per month but $2,500 goes to the house (including escrow), so we live on $2,500 per month with no debt but the house right now and an extra 8% would mean having to cut our monthly living costs to $1,833/month, which is a huge cut given we have no debt but the house.

I understand contributing 15% of my income, but is that 15% total household income, or 15% each for my wife and I (totalling 30%)? Thanks.

I think it’s 15% of total income.

Rob which calculator did you use on your 1st example of A 10% Savings Rate Example

15% is good 16% the next year is better 17% the next tear is even better.

Keep going till you match what you can put in.

Thank you for providing the link to the Roth 401k vs. Traditional 401k calculator. I ran a few different scenarios and feel like I made the best decision investing in a Roth 401k at my company. I am hopeful this will add at least $250,000 in additional funds by the time I am 65 (I am 30 now). I read in a recent Vanguard report that only 15% of people who have access to a Roth 401k are using it. That is likely going to increase significantly once people learn more about the real advantages of a Roth 401k vs. a Traditional 401k – especially younger investors.

Is the money I put into a Roth IRA actual money or do I have to buy mutual funds and then put those in it? I’m 26 and would like to get a handle on this ASAP. I am a teacher so I am currently contributing 4% of my check to the retirement system which will pay me back when I retire, but I also want to have extra in case. Thanks!

Sarah,

You can hold mutual funds within a Roth IRA, but you can simply deposit cash within an IRA, too. Personally, I have a Roth IRA through Fidelity and just deposit a percentage of my pay each month.

Hope that helps!

Stephanie

I am thinking the same as Bruce. I just plugged in some numbers in Excel (using FV formula), and if you assumed the same tax bracket, you’d end up with the same amounts. The decision to go Roth vs. Traditional, I think, should not be math based, but rather depending on your view of the final points of the article. Personally, I am hoping to decrease my tax rate in retirement.

My quick concern is the part of compounding returns.

To me, it seems stocks (mutual funds in 401k) do not really do compounding returns, and I am challenged to find any investment that return 10% per year interest.

I appreciate replies on this item.

The analysis is flawed. Assuming equivalent contributions to a Roth and an Roth IRA both will yield the same dollars in the future – assuming the tax rate stays the same. For example, saving 20,000 per year in a Roth IRA account savings account is equivalent to saving 15,000 in a Roth after tax account. Both will cost 20,000 net of taxes. At the end of any time period or interest rate assumption the two will yield the same after tax balances. Basic math. Any calculation that yields different results has been artificially tilted in favor of one account or the other. Bottom line: the same dollars out of your pocket today yields the same dollars back in the future. The only way that is not true is if you assume different tax rates in the future.

Agree with gb, most do not make 100k for 35 years unless your are selling books to people who can’t plan for their future (rolling my eyes). THE PART THAT REALLY MAKES THIS SILLY IS THERE IS NO WAY YOU CAN AVERAGE 10% FOR 30 YEARS. Sorry, this is dangerous thinking. People will make poor choices based upon fiction. Roth decisions are made because of future tax brackets, and that is determined (in part) by how much your investments make, 10 percent is a dangerous presumption. This should be removed.

I can’t even average 10% for 2 years. My 5 year average is something like 1-2% ROI. It’s terrible, I don’t know what to do.

Me to… turned 30 this past March. I love to invest and made the mistake of liquidating stocks for a business instead of looking for the money elsewhere. I feel the impact even now becuase i started the portfolio in the gutter of 08. I would be significantly great right now. ;0( learn from your mistakes.

I like Ramsey but these numbers are totally unrealistic. Who is making 100k for 35 years? The graphs assume you are making 100k salary for 35 years…meaning you start saving 15k a year at 30. How may 30 year olds are making a 100k?

:::timidly raises hand:::

I am 60 and have $335,000 invested of which $234,000 is in a ROTH IRA and the balance in a 401B. If I retire at 62, approximately how much monthly income can I expect between these two investments?

Thank-you

OK – so I am in a high income bracket whereby IRA/Roth are not tax-deductible. My 401(k) is maxed out annually (@6%), but I need to put more into retirement to reach the 15% pre-tax goal.

What options are available here?

I am the same situation. I don’t see a benefit to putting money into a roth or trad IRA becuase my account says i can’t. Ex becuase of my current 401K and level of income. What other options are there??? I am looking into single investor accounts for Mutual Funds, ETFs, etc.

Thanks for the help.

BR

Mike

What software was used for the graphs shown above? I would like to run some different scenarios and show my kids how compound interest and time impact the savings you end up with at retirement. I like that this one has inflation included with this and you can show the numbers with it it factored in and not.

Please email me the information. Thanks.

Bankrate.com is the source of those calculators.

John, these decisions are never easy. In making the decision, you may want to consider: (1) your wife’s ability to generate income; (2) other retirement assets you have, (3) life expectancy (I gather the high life insurance premiums related to the disability). My preference would be to take the single option and make up the difference with life insurance if the numbers work out, but it looks like that choice may not save you anything save you anything. The short answer is that there are no easy answers. You could always consult a certified financial planner, but ultimately they are just going to work out the numbers based on a variety of assumptions, and you’ll still be left making a decision with less than perfect information.

I’m a retiring police officer on 3/4 tax free pension disability. I’m 43 soon to be 44. I’ll be making around $122000 if I take the single life option but I’m married and my wife is 15 years my junior causing a substantial drop in income if I choose the joint option. It would cost me $12.400 annually if I choose the joint option.

I hear so much about pension maximization but when I looked into a 2 million dollar term policy, the premiums almost amount to the sure fire joint pension option. I have to make this decision rather soon. Please advise me.

Thank you.

oops. it would be a total of 23%. sorry.

Is the 15% goal all my money or is that including company match? My company will throw in up to 8% as long as I contribute at least 3%. So…to hit 15% I’d only have to put in 7% of my income. Or should I be putting in 15% of my money for a total of 25%?

Thanks!

Andy, I believe Dave Ramsey’s view is to ignore company match because you may change jobs to one that doesn’t offer the match. My view is that if you are saving 15% including the company match, you doing just fine.

I am 17 years old and just opened up a mutual fund and I plan on putting 50-75 dollars a month in till im 45-50 years old . does anyone else have any suggestions that could help me now or in the long run??

Thank you!

Danny, just the fact that you are 17 and thinking so far into the future is a great start. But what kinds of suggestions are you looking for?

Mr. Duncan,

You have given me new hope for the future of our younger generation! I wish that I had been smart enough at 17 to do what you are doing. DR is right, the fact that you are even thinking about it now makes you a Rock Star! But you asked for recommendations so, I would recommend a couple of things:

1. You say you “plan” on saving each month. I would recommend making that plan into a written budget EVERY month, before the month begins, as Dave Ramsey suggests.

2. If you haven’t heard of Dave Ramsey, start with his book “The Total Money Makeover”. You can even check it out from the library. Follow Dave’s “Baby Steps” and you will be a multi-millionaire before you know it!

3. When you find yourself on track and ready to start GIVING a bunch of your wealth away, start by finding a 17 year old like yourself now and pay it forward.

When you are young….you learn, when you are a bit older……you earn, and when you reach retirement time…..you return. (Learn/Earn/Return)

Thanks,

Quinn C.

There are three phases of life: “Learn, Earn, Return” – Jack Balousek

Sorry, I forgot to give credit for the quote. I heard it from someone I work with when they retired and it stuck with me. I never really knew the source, but now we all do! 🙂

Very thorough analysis with 1 exception: those of us that are limited in the amount we can invest. I can only invest 10% of my income in the company 401K and I don’t qualify for a Roth IRA either. What recommendations do you have for the additional 5% to get to 15% overall retirement investments?

YG, great question. Just published an article with my thoughts on the question you raise, which you can read here.

I am investing 15% in a tradiational retirement plan, My company matched 4 1/2%. We have both Pretax and post tax. Would you advice me to switch to posttax? and should I invest all 15% in my company or can i just invest 4 1/2% of my gross and then 91/2% in Roth IRA?

I switched ALL to Roth (post-tax) up to the match and I put the rest into Roth IRAs. I strongly support Dave’s philosophy here. Anything less than the match, however, is throwing money away. I don’t think there’s a company out there that will match the 4.5% on Roth and 4.5% on traditional but it’s worth asking your employer. My company only matches up to 5 % TOTAL. Good luck.

Hello.

I am understanding that that the max annual contribution for 401K is now $15,500. And that is a combination of both the company match and my contribution, correct?

But the 15% of overall savings includes the 401K, Roth IRA and savings accounts?

If the company match can only go into a traditional 401K, can I put my contribution into a Roth 401K? Or does it all need to be in the same type of 401K, still with a max ann contrib of $15,500

total?

Thank you for the help.

Susan, your contribution limitation is $15,500, and the company match is on top of that. So combined, you could be saving more than $25,000 a year if your company matches dollar for dollar. Note that because of IRS regulations, they won’t match all the way up to $15,500; I think it stops between $12,000 and $13,000. Also, where I work, all matching contributions are to the traditional 401k, regardless of whether I contribute to the Roth 401k. I’m not sure if that’s how it works everywhere, but your HR folks could answer that question for you. Best of luck!

Here’s my situation: I’m investing 16% pretax into a regular 401(k) so I can get the 4% company match.

I don’t have any more retirement investing money left over, and I don’t have access to a Roth 401(k). Is that 4% match worth it? Or would I be better off vastly lowering the contributions to the employer plan, losing some of the free money, and maxing out the Roth IRA contributing?

I know there are no guarantees, but it’s an interesting puzzle I haven’t seen explored elsewhere.

Quick question – does the 15% include the company match, or is the company match just gravy on top of 15% from your pocket?

Dave Ramsey’s approach is to view the company match as gravy. The theory is that you could change jobs and work for an employer that doesn’t match 401(k) contributions. But there is no “right” or “wrong” answer here. The more you save, the more you have.

I have a question. If you have Roth 401k at work, is it better to invest all in your Roth 401k or do up to the match in the Roth 401k and then up to the maximum in a Roth IRA?

I suspect Dave would say to split it to get to your 15% since you have more control over the Roth IRA than you do over the Roth 401k…

I agree that Dave Ramsey would prefer the Roth retirement accounts, and frankly, so do I. I like the certainty they bring to retirement planning. Of course, it costs more now to max out a Roth account than it does a traditional retirement account, so it depends in part on how much you have to invest. It also assumes you qualify for a Roth 401(k). The other benefits of a Roth IRA include greater investment options (you chose where to open the account and what to invest in; you aren’t limited to your employer’s choices), and there is no required distributions from a Roth IRA during retirement.

Glad you mentioned 15% is not enough for older people. I would argue even in your 30s and nothing saved, you might have to ramp it up more.

Why would you invest the tax savings into a taxable account – I thought with a 401k the employer contributes a before tax amount and you don’t end up paying tax on that contribution?

Mike