How Much Should You Save for Retirement? Dave Ramsey’s Plan
Learn Dave Ramsey's clear, actionable plan for how much to save for retirement, integrating it with your overall financial well-being.
Foundations of Dave Ramsey’s Approach
Dave Ramsey’s financial philosophy is built upon “Baby Steps” designed to guide individuals toward financial independence. These steps prioritize a stable financial foundation before significant wealth building, including retirement savings. Initial steps focus on creating a financial safety net and eliminating debt, which Ramsey views as prerequisites for effective investing.
The first step involves saving a starter emergency fund of $1,000. This fund acts as a buffer against unexpected expenses, preventing new debt from unforeseen events like car repairs or medical bills.
Following this, the second Baby Step focuses on paying off all non-mortgage debt using the “debt snowball” method. This involves listing debts from smallest to largest, paying minimums on all but the smallest. Once the smallest is paid, its payment is applied to the next, accelerating debt elimination. Ramsey emphasizes that quick wins motivate commitment to becoming debt-free.
Once non-mortgage debt is eliminated, the third Baby Step involves fully funding an emergency savings account with three to six months’ worth of living expenses. This larger fund provides a comprehensive safety net for major life disruptions like job loss or medical emergencies, without relying on debt. Completing these foundational steps provides financial stability before moving to long-term investing goals like retirement.
Dave Ramsey’s Retirement Savings Strategy
After establishing a solid financial foundation by eliminating consumer debt and securing a fully funded emergency fund, Dave Ramsey’s plan shifts to aggressive retirement savings. His primary recommendation is to invest 15% of your gross household income into retirement accounts. This percentage includes any employer contributions, such as a 401(k) match; if an employer contributes 3%, you would aim to contribute an additional 12%.
This 15% is applied to your total income before taxes and deductions. For example, a household earning $80,000 annually would aim to invest $12,000 per year. Ramsey advises prioritizing tax-advantaged accounts due to their potential for tax-free growth or deductions.
He recommends Roth IRAs and employer-sponsored 401(k)s, especially those with a Roth option. A Roth IRA is funded with after-tax dollars; contributions are not tax-deductible, but qualified withdrawals in retirement are tax-free. This is advantageous if you anticipate a higher tax bracket in retirement. For higher incomes exceeding Roth IRA limits, a Roth 401(k) offers similar tax-free growth and withdrawals.
Ramsey advocates investing retirement savings within mutual funds. He suggests diversifying across four types: growth, aggressive growth, growth and income, and international. This strategy aims to reduce risk through broad diversification across industries and global markets.
The approach leverages compound growth over time, allowing investments to grow significantly over decades. The goal is to accumulate enough wealth to replace a substantial percentage of pre-retirement income, commonly 80% or more, ensuring a secure retirement.
Balancing Retirement with Other Financial Goals
Once retirement savings are underway at 15% of gross income, Dave Ramsey’s plan integrates other financial objectives. The fifth Baby Step focuses on saving for children’s college education. Individuals can contribute to Education Savings Accounts (ESAs) or 529 plans. ESAs allow for tax-free growth and withdrawals for qualified education expenses. 529 plans also offer tax-advantaged growth, with tax-free withdrawals for eligible educational costs.
The sixth Baby Step involves paying off your home mortgage early. With consumer debts eliminated, an emergency savings funded, and retirement contributions on track, extra income is directed towards accelerating mortgage payoff. This step aims for complete debt freedom, providing financial peace and flexibility in retirement.
The final stage, Baby Step 7, focuses on building wealth and giving. Individuals are typically debt-free, including their mortgage, and have consistent retirement savings. The emphasis shifts to maximizing wealth accumulation through continued investing, often beyond the initial 15% contribution, and engaging in generous giving. This approach shows how retirement savings are part of a broader financial journey, leading to financial freedom where wealth can be grown and shared.