If you are able to, you should max out both you 401k and you Roth IRA when you start working. Right now the IRA contribution limit it $5,500 and the 401k limit is $18,000+Match (assume a $2,500 match). Maxing out both of these accounts would come to a total contribution of $26,000.
Assuming a 6.2% after-inflation rate of return (this is the 100 year annualized market return and inflation value), after 6 years of contributions you should have approximately $180,000 after inflation. Assuming that you stop making any contributions at age 28, and the accounts can grow at the same rate of return until you reach traditional retirement at age 60, the accounts would be worth nearly $1.4 million in today’s dollars, and it would produce about $56,000 in annual income.
That seems like a great deal doesn’t it? All you would have to do is max out the accounts for just 6 years, allow compounding to do the rest, and be able to enjoy the median household income every year once you reach 60.
In practice, however, the opportunity cost of taking money out of these tax advantaged accounts is relatively high, and you might be inclined to not take withdrawals until age 65 or even later. In our scenario, those extra 5 years of compounding could create over $400,000 in real extra wealth, which would allow someone to spend $70,000 annually in traditional retirement.
In reality, what one should do is work backwards using some initial targets in order to determine what their savings level needs to be. For example, if your goal was to have $100,000 in annual passive income from your retirement accounts by the age of 65, you would do the following calculations:
$100,000 in Annual Passive Income
/ 4% = $2,500,000 in today’s $ needed
* (1.035^45) = $11,800,000 in 2058 dollars needed (inflation)
/ (1.1^35) = $420,000 needed by age 30
pmt(10%, 10, 0, $420,000) = $26,000 needs to be saved annually for 10 years.