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How to Build a Retirement Plan From Scratch

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How to Build a Retirement Plan From Scratch

Retirement planning is one of those tasks that most people know they should do but keep pushing off. A Bankrate survey found that 55% of Americans feel behind on their retirement savings, and one in five working-age adults has nothing saved at all. The reasons for delay are understandable -- retirement feels decades away, the financial jargon is intimidating, and today's bills always feel more urgent. But the math of compounding is merciless: every year you wait costs you exponentially more than the year before.

The good news is that building a retirement plan is not as complicated as the financial industry wants you to believe. You do not need a financial advisor, a finance degree, or a complicated spreadsheet. You need seven straightforward steps, a willingness to start where you are, and the discipline to keep going.

Step 1: Estimate Your Retirement Expenses

Before you can figure out how much to save, you need to estimate how much you will actually spend in retirement. The most commonly cited guideline is the 80% rule -- plan to spend roughly 80% of your pre-retirement income each year. If you earn $80,000 per year now, that means budgeting around $64,000 per year in retirement.

The 80% rule is a useful starting point, but it is only a rough guide. Some expenses decrease in retirement -- you will no longer pay payroll taxes, commuting costs, or work wardrobe expenses, and your mortgage may be paid off. But other costs often increase, especially healthcare. Fidelity estimates that the average 65-year-old couple retiring today will need approximately $315,000 for healthcare expenses alone over the course of their retirement.

For a more accurate estimate, look at your current spending and make realistic adjustments. If you plan to travel extensively, your number might be higher than 80%. If you live in a paid-off home in a low-cost area and have modest tastes, it might be lower.

The key takeaway: Pick a number, even an imperfect one. A plan built on a rough estimate is infinitely better than no plan at all.

Step 2: Calculate How Much You Need

Once you have an annual spending estimate, the next question is: how large does your nest egg need to be? Two closely related rules make this simple.

The 4% safe withdrawal rate -- sometimes called the Trinity Study rule -- states that you can withdraw 4% of your portfolio in your first year of retirement, then adjust for inflation each year after that, and your money has a high probability of lasting at least 30 years. This was derived from historical analysis of stock and bond returns dating back to 1926.

The inverse of 4% gives you the 25x rule: multiply your annual retirement spending by 25 to get your target nest egg.

  • $40,000/year spending requires $1,000,000
  • $60,000/year spending requires $1,500,000
  • $80,000/year spending requires $2,000,000
  • $100,000/year spending requires $2,500,000

These numbers look large, and they are. But remember, you are not saving this amount from your paycheck alone -- compound growth does most of the work. Someone who invests $500 per month starting at age 25 with a 7% average annual return will have over $1.2 million by age 65. The same person starting at age 35 would end up with roughly $567,000 -- less than half as much despite only missing 10 years.

Step 3: Account for Social Security and Pensions

Social Security will likely provide some income in retirement, but you should not build your entire plan around it. The Social Security Administration projects that the trust fund will be depleted by the mid-2030s, at which point benefits could be reduced to about 77% of scheduled amounts unless Congress acts. Even at full benefits, the average Social Security check in 2024 is roughly $1,900 per month -- enough to cover basic necessities in many areas, but not enough to fund a comfortable retirement on its own.

If you have a pension from an employer, that is a valuable asset. But pensions are increasingly rare in the private sector. If you have one, factor in the expected monthly benefit, but consider what happens if the pension fund faces financial difficulties.

A prudent approach: Calculate your retirement target as if Social Security and pensions will cover roughly 50-70% of their projected amounts. If they pay out in full, you will have a comfortable buffer. If they do not, you will still be okay.

Step 4: Choose Your Retirement Accounts

Not all savings accounts are created equal. The retirement accounts available to you offer significant tax advantages that can add hundreds of thousands of dollars to your final balance. Here are the accounts you should know.

401(k) and 403(b) Plans

If your employer offers a 401(k) (private sector) or 403(b) (nonprofits and education), this is usually the best place to start. Contributions are made with pre-tax dollars, reducing your taxable income today. Many employers also offer a matching contribution -- for example, matching 50% of your contributions up to 6% of your salary. On a $70,000 salary, that match is worth $2,100 per year in free money. Not taking the full match is the single most expensive mistake in retirement planning.

The contribution limit for 2024 is $23,000 per year (under age 50). Investments grow tax-deferred, and you pay income tax when you withdraw in retirement.

Traditional IRA vs. Roth IRA

Both Individual Retirement Accounts (IRAs) offer tax advantages, but they work in opposite directions.

A Traditional IRA gives you a tax deduction today. You contribute pre-tax dollars, your investments grow tax-deferred, and you pay income tax on withdrawals in retirement. This is advantageous if you expect to be in a lower tax bracket in retirement than you are now.

A Roth IRA works in reverse -- you contribute after-tax dollars (no deduction today), your investments grow tax-free, and withdrawals in retirement are completely tax-free. This is advantageous if you expect your tax rate to be higher in retirement, or if you simply want the certainty of knowing your retirement income will not be diminished by taxes. Roth IRAs also have no required minimum distributions, making them excellent tools for estate planning.

The contribution limit for either IRA type is $7,000 per year (under age 50) in 2024. Income limits apply for Roth IRA contributions -- in 2024, the ability to contribute phases out between $146,000 and $161,000 for single filers.

If you are unsure which to choose: For most people under 40, a Roth IRA is the better bet. Your current tax rate is likely lower than it will be later in your career, and you lock in decades of tax-free growth.

HSA: The Stealth Retirement Account

A Health Savings Account (HSA) is the most tax-advantaged account in the entire tax code, and most people overlook it for retirement. If you have a high-deductible health plan, you can contribute to an HSA and receive a triple tax benefit: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free.

Here is the retirement angle: after age 65, you can withdraw HSA funds for any purpose -- not just medical expenses -- and pay only ordinary income tax, just like a Traditional IRA. But unlike a Traditional IRA, you got the tax deduction going in and tax-free growth along the way. And if you use the funds for medical expenses at any age, the withdrawal is completely tax-free.

The 2024 contribution limit is $4,150 for individuals and $8,300 for families. If you can afford to pay current medical expenses out of pocket and let your HSA grow, it becomes a powerful retirement vehicle.

Taxable Brokerage Accounts

Once you have maxed out your tax-advantaged accounts, a taxable brokerage account provides flexibility that retirement accounts cannot. There are no contribution limits, no early withdrawal penalties, and no required minimum distributions. You will pay capital gains taxes on investment profits, but long-term capital gains rates (0%, 15%, or 20%) are lower than ordinary income tax rates for most people.

Taxable accounts are also essential for early retirement -- if you plan to retire before age 59 1/2, you will need accessible funds to bridge the gap before you can tap retirement accounts penalty-free.

Step 5: Set Your Contribution Targets

Now that you know which accounts to use, how much should you put in?

The minimum: Contribute at least enough to your 401(k) to capture your employer's full match. If your employer matches 50% up to 6%, contribute at least 6%. Anything less is leaving guaranteed, immediate 50% returns on the table.

The target: Aim for 15-20% of your gross income across all retirement accounts. This is the range that most financial planners agree gives you a strong probability of replacing your income in retirement, assuming you start in your mid-twenties to early thirties. If you start later, you may need to save a higher percentage.

If 15% feels impossible right now, start with what you can -- even 5% or 6% -- and increase by 1-2% each year. Many 401(k) plans offer auto-escalation features that will increase your contribution rate automatically each year. Use them.

Catch-up contributions after 50: Once you turn 50, the IRS allows additional contributions. In 2024, you can contribute an extra $7,500 to your 401(k) (total of $30,500) and an extra $1,000 to your IRA (total of $8,000). If you are behind on savings, these higher limits provide a meaningful opportunity to close the gap.

Step 6: Choose Your Investments

Having the right accounts funded with the right amounts is critical, but what you invest in matters too. The good news is that simplicity wins here.

Target-Date Funds

If you want a one-fund, set-it-and-forget-it solution, a target-date fund is hard to beat. You pick the fund closest to your expected retirement year (for example, a 2055 fund if you plan to retire around 2055), and the fund automatically adjusts its mix of stocks and bonds over time -- aggressive when you are young, conservative as you approach retirement. Vanguard, Fidelity, and Schwab all offer excellent low-cost target-date funds with expense ratios below 0.15%.

Three-Fund Portfolio

If you prefer more control, the classic three-fund portfolio is a time-tested approach:

  1. U.S. Total Stock Market Index Fund -- broad exposure to domestic stocks
  2. International Stock Market Index Fund -- diversification across global markets
  3. U.S. Total Bond Market Index Fund -- stability and income

This approach keeps costs extremely low (expense ratios of 0.03-0.10%) and provides broad diversification. You adjust the allocation between stocks and bonds based on your age and risk tolerance.

Asset Allocation by Age

A widely used guideline is the "110 minus your age" rule for determining your stock allocation. If you are 30 years old, put roughly 80% in stocks and 20% in bonds. If you are 50, aim for 60% stocks and 40% in bonds. This is a starting point, not gospel -- your personal risk tolerance, other income sources, and retirement timeline all play a role.

The critical principle: when you are young, you can afford to be aggressive. A market downturn at age 30 is a buying opportunity. A market downturn at age 62 is a serious threat to your retirement date. Your allocation should reflect that reality.

Step 7: Automate and Review Annually

The most important step in any retirement plan is removing willpower from the equation. Set up automatic contributions from your paycheck or bank account so that saving happens before you ever see the money. Studies consistently show that automatic enrollment and automatic escalation dramatically increase retirement savings outcomes.

Once a year -- and no more often than that -- review your plan:

  • Are your contributions on track to meet your target savings rate?
  • Has your income changed, allowing you to increase contributions?
  • Is your asset allocation still appropriate for your age?
  • Are you rebalancing your portfolio to maintain your target allocation?
  • Have your retirement goals or timeline changed?

Resist the urge to check your portfolio daily or react to market volatility. The S&P 500 has historically returned about 10% annually over long periods, but in any given year it might be up 30% or down 30%. Staying invested through the downturns is what separates successful long-term investors from everyone else.

Common Retirement Planning Mistakes

Even well-intentioned planners fall into traps. Here are the most costly ones:

  • Waiting to start. Every year of delay costs you more than the last. Starting at 25 instead of 35 can mean the difference between $1.2 million and $567,000 with the same monthly contribution.
  • Not taking the full employer match. This is a guaranteed, immediate return on your money. There is no investment on earth that offers a better deal.
  • Cashing out a 401(k) when changing jobs. You will pay income tax plus a 10% penalty, losing up to 40% of the balance. Roll it into an IRA instead.
  • Being too conservative too young. Holding all bonds or cash at age 30 means inflation erodes your purchasing power. You need stock market growth when time is on your side.
  • Ignoring fees. A 1% difference in fund expense ratios can cost you hundreds of thousands of dollars over a 40-year career. Choose low-cost index funds whenever possible.
  • Raiding retirement accounts for non-emergencies. Early withdrawals come with taxes and penalties, and you lose the future compounding on that money permanently.
  • Failing to plan for healthcare costs. Medical expenses are one of the largest costs in retirement. An HSA and supplemental insurance planning can help manage this risk.

The Bottom Line

Building a retirement plan from scratch is not about perfection -- it is about progress. Estimate your expenses, calculate your target, open the right accounts, contribute consistently, invest simply, and automate everything. The details matter less than the act of starting. A 25-year-old who saves $300 per month in a low-cost index fund will almost certainly retire more comfortably than a 45-year-old who spends years researching the perfect strategy before contributing a dime.

Start where you are. Use the calculators below to model your specific situation. And remember -- the best retirement plan is the one you actually follow.

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