High inflation levels have eroded many Americans’ confidence in their retirement preparedness. According to the 2023 Northwestern Mutual Planning and Progress Study, U.S. adults aged 18 or older expect they will need $1.27 million to retire comfortably, a 20 percent rise since 2021.  Luckily, Americans’ average retirement savings increased a bit to $89,300.

The good news is that there are many different retirement savings options available, including an individual retirement account, or IRA, which is an effective savings tool because it allows you to access financial markets in a tax-advantaged way.  

How does an IRA work? 

An IRA is a tax-advantaged account that allows you to save for retirement. Depending on which option you choose, IRAs offer tax-deferred or tax-free growth. There are traditional and Roth IRAs. 

Roth IRA vs. traditional IRA  

What's the difference between a Roth IRA and a traditional IRA? 

Traditional IRA contributions are tax deductible today, but you’ll pay income tax when you withdraw that money in retirement. With a Roth IRA, you pay taxes on contributions today, but that income won’t be taxed later — so long as you adhere to withdrawal rules. When you have savings in both types of accounts, it’s a little easier to manage the amount of income tax you pay in retirement.   

But how much should you contribute to an IRA, and how often should you do it?

How much should I contribute to an IRA? 

Know yourself. What kind of life do you want to live in retirement? Some people want to travel, some plan to golf daily while others plan to downsize and live closer to the grandkids. These decisions will impact how much you will need to save to support your lifestyle. A simple, back-of-napkin way to estimate your financial need in retirement is the “Multiply by 25 Rule.” Start with an annual income you’ll be comfortable with in retirement, say, $60,000, and multiply it by 25. That comes out to $1.5 million you’ll need to save to support your desired annual income for 25 years (the average length of retirement in the U.S. is 18 years, according to the U.S. Census Bureau).  

Now, this is hardly an exact figure and you probably wouldn’t build a financial plan around it alone. The rule doesn’t factor in tax law changes, inflation, market performance or the fact that retirement can last longer than 25 years. However, it does provide a ballpark figure to see if you’re at least on the right track.  

Roth and traditional IRA contribution limits 

Know your contribution limits.  

The maximum amount you can contribute to a traditional IRA or Roth IRA (or combination of both) in 2023 is capped at $6,500. Viewed another way, that’s about $542 a month you can contribute throughout the year. If you’re age 50 or over, the IRS allows you to contribute up to $7,500 annually (or $625 a month). Note that there are income limits for Roth IRA eligibility. 

If you can afford to contribute around $500 a month without neglecting bills or yourself, go for it! Otherwise, you can set yourself up for success if you can set aside about 20 percent of your income for long-term saving and investment goals like retirement.  

Prioritize high-interest debt, but don’t ignore other goals. Indeed, an IRA is an excellent way to save for retirement, but if you have a lot of high-interest credit card debt you’ll want to expedite paying that. Federal Reserve data show credit card interest rates on balances hover around 16 to 20 percent, while long term, the stock market has generated average annual returns of roughly 10 percent (7 to 8 percent accounting for inflation), according to the U.S. Securities and Exchange Commission. Clearly, there’s a pretty good chance interest costs will outpace your potential for gains.  

Now, prioritizing high-interest debt doesn’t mean neglecting your retirement savings, paying student loans, building your emergency fund or saving for a big trip. However, you want that bad debt off the books as soon as you can manage (without impacting other goals) so your growth isn’t hampered by those pesky interest costs. Maybe instead of contributing $500 a month to an IRA, you bring it down to $250 while using the difference to accelerate payments on debt. With the right plan, you can balance current priorities while setting yourself up well for the future.

When should I contribute to an IRA? 

The earlier the better. With investing, time is your greatest asset. That means the sooner you start saving the longer it can grow. If you invest $10,000 and generate the average 7 percent, inflation-adjusted market return, it would be worth $19,000 after 10 years, $54,000 in 25 years, $149,000 in 40 years. Keep in mind the market may return more, or even yield negative returns, in a given year. But over long periods of time, as you can see, time in the market has a pretty big impact on growth.  

Again, if you haven’t started saving for retirement don’t worry. It’s never too late to start.  

IRAs and 401ks 

Get that match. If you have a 401(k), you can still contribute the maximum allowed to an IRA, Roth IRA (within income restrictions) or combination of both. Here’s the thing, some employers offer matching contributions in their 401(k) plans. If your employer matches contributions, dollar-for-dollar, up to 6 percent of your salary, make sure you’re contributing at least 6 percent from each paycheck first. It’s free money, so don’t leave that on the table!  

Once you’ve at least hit your match, you can keep funneling up to $22,500 annually into a 401(k) per current 2023 IRS rules, or you can divert funds above and beyond your employer match into your Roth IRA or traditional IRA – whichever works best for your plan. And if you’re at a point where you’ve maxed out your 401(k), an IRA is a great way to capitalize on additional tax-advantaged retirement savings, depending on your income and tax filing status. 

How often should I contribute to an IRA? 

Make it consistent. The other key is to make consistent contributions — even better to automate the process altogether (contact your HR department to set up automatic paycheck contributions or set up an automatic transfer from your bank). For one, this ensures you’re making saving a habit. But there’s an additional benefit, known as dollar-cost-averaging.   

It works like this: If you want to max out your IRA, you could invest $6,500 all at once, or you could invest about $542 each month. Investing in increments is one way to dull the psychological impact of market volatility because you aren’t watching a large sum of money potentially decline in value out of the gate. Dollar-cost averaging may also help you arrive at a better average price for your portfolio investments. 

If you have the funds and can stomach a little volatility, a Northwestern Mutual analysis shows investing a lump sum all at once tends to outperform dollar-cost averaging over the long run. Regardless, it’s beneficial to develop a consistent investment strategy that works for you and makes it easier to participate in markets for the long term.  

Need a little help? We get it. Maybe you have student loans, or credit card balances to pay. Maybe you want to travel while you’re still young or you’re planning to put money into a new business venture. Heck, for many people, the idea of monitoring all these accounts sounds worse than nails on a chalkboard. Fortunately, you don’t need to do this on your own.  

If you feel like you could use a little help managing today while building for tomorrow, a financial professional can help you build a plan that can help you live the life you want to – not only today, but decades from now.  

All investments carry some level of risk including the potential loss of all money invested. Past performance is no guarantee of future performance. No investment strategy can guarantee a profit or protect against a loss.

This article is provided by Northwestern Mutual. Learn more about retirement planning from a licensed financial advisor using our one-of-a-kind Find An Advisor tool.