Reviewed by Margaret James
Fact checked by Suzanne Kvilhaug

Proper management of working capital is essential to a company’s fundamental financial health and operational success as a business. A hallmark of good business management is the ability to utilize working capital management to maintain a solid balance among growth, profitability, and liquidity.

A business uses working capital in its daily operations; working capital is the difference between a business’s current assets and current liabilities or debts. Working capital serves as a metric for how efficiently a company is operating and how financially stable it is in the short term. The working capital ratio, which divides current assets by current liabilities, indicates whether a company has adequate cash flow to cover short-term debts and expenses.

Key Takeaways

• The goal of working capital management is to maximize operational efficiency.
• Efficient working capital management helps maintain smooth operations and can help to improve the company’s earnings and profitability.
• Management of working capital includes inventory management and management of accounts receivable and accounts payable.

The Importance of Working Capital Management

Working capital is a daily necessity for businesses, as they require a regular amount of cash to make routine payments, cover unexpected costs, and purchase basic materials used in the production of goods.

Efficient working capital management helps maintain smooth operations and can help to improve the company’s earnings and profitability. Management of working capital includes inventory management and management of accounts receivable and accounts payable. The main objectives of working capital management include maintaining the working capital operating cycle and ensuring its ordered operation, minimizing the cost of capital spent on the working capital, and maximizing the return on current asset investments.

Working capital is an easily understandable concept, as it is linked to an individual’s cost of living, and therefore can be understood in a more personal way. Individuals need to collect the money that they are owed and maintain a certain amount on a daily basis to cover day-to-day expenses, bills, and other regular expenditures.

Breaking Down Working Capital Management

Working capital is a prevalent metric for the efficiency, liquidity, and overall health of a company. It is a reflection of the results of various company activities, including revenue collection, debt management, inventory management, and payments to suppliers. This is because it includes inventory, accounts payable and receivable, cash, portions of debt due within a year, and other short-term accounts.

The needs for working capital vary from industry to industry, and can even vary among similar companies. This is due to several factors, including differences in collection and payment policies, the timing of asset purchases, the likelihood of a company writing off some of its past-due accounts receivable, and in some instances, capital-raising efforts that a company is undertaking.

Important

When a company does not have enough working capital to cover its obligations, financial insolvency can result and lead to legal troubles, liquidation of assets, and potential bankruptcy.

Working capital management is essentially an accounting strategy with a focus on the maintenance of a sufficient balance between a company’s current assets and liabilities. An effective working capital management system helps businesses not only cover their financial obligations but also boost their earnings.

Managing working capital means managing inventories, cash, accounts payable, and accounts receivable. An efficient working capital management system often uses key performance ratios, such as the working capital ratio, the inventory turnover ratio, and the collection ratio, to help identify areas that require focus in order to maintain liquidity and profitability.

What Is Working Capital?

Working capital is the difference between a company’s current assets and its current liabilities. It’s a commonly used measurement to gauge the short-term financial health and efficiency of an organization.

Current assets include cash, accounts receivable, and inventories of raw materials and finished goods. Examples of current liabilities include accounts payable and debts.

What Is Working Capital Management?

Working capital management is a business strategy designed to manage a company’s working capital. It ensures that a company operates efficiently by monitoring and using its current assets and liabilities to their most effective use.

What Are Some Real-World Examples of Working Capital Management?

Real-world examples of working capital management include:

• Apple Inc. (AAPL), which closely manages its inventory levels, negotiates favorable payment terms with suppliers, and carefully monitors its accounts receivable and accounts payable
• Walmart Inc. (WMT), which negotiates favorable payment terms with suppliers and whose supply chain and inventory management system allows it to minimize inventory holding costs while meeting customer demand

The Bottom Line

Working capital management aims to maximize a company’s operational efficiency. Efficient working capital management not only helps maintain smooth operations, but also can help to improve earnings and profitability and maintain a solid balance between growth and liquidity.

Reviewed by Thomas J. Catalano
Fact checked by Michael Rosenston

Many people struggle to set aside the money they need to build up their retirement nest eggs, month by month. Fortunately, a nonrefundable tax credit, known as the retirement savings contributions credit, can make it substantially easier to save.

Usually referred to as the Saver’s Credit, it provides individuals and families with modest incomes a tax break above and beyond any deductions that they may receive from contributions to their individual retirement accounts (IRAs) or employer-sponsored plans.

By reducing the person’s income tax bill for the year, the credit offsets the cost of funding a retirement account, ultimately bolstering their long-term savings over time.

Key Takeaways

• A tax credit reduces the amount of taxes owed dollar for dollar. That’s better than a tax deduction, which reduces the taxpayer’s total taxable income.
• The saver’s tax credit is available to eligible taxpayers who contribute to an employer-sponsored retirement plan, ABLE plan, or a traditional and/or Roth IRA.
• The amount of the credit is determined by a number of factors, including the person’s retirement plan contributions, tax filing status, and adjusted gross income (AGI).
• This credit is not available to people under age 18, full-time students during any part of five calendar months (not necessarily consecutive) during the tax filing year, or anyone claimed as a dependent by another taxpayer.
• You can use Form 8880 to calculate and claim the saver’s tax credit.

What Is the Saver’s Tax Credit?

The saver’s tax credit is available to eligible taxpayers who contribute to employer-sponsored 401(k), 403(b), SIMPLE, SEP, thrift savings plans (TSPs), or governmental 457 plans. It is also available to those who contribute to traditional or Roth IRAs.

Those who make contributions to these types of accounts on behalf of other people with disabilities and their families (known as ABLE accounts) also are eligible for the saver’s tax credit.

AGI Determines Amount of Credit

Your adjusted gross income (AGI) determines your credit amount, which can be either 50%, 20%, or 10% of a maximum contribution amount. The maximum contribution amount that qualifies for the credit is $2,000, or $4,000 for married couples filing jointly.

The credit rate that you can apply depends on your AGI and filing status. If your income rises above the maximum AGI limit, you can’t claim the credit.

For the 2024 tax year, the maximum AGI limits were $76,500 for married couples filing jointly; $57,375 for heads of household; and $38,250 for singles and married individuals filing separately. Income beyond these maximums disqualified you from claiming the credit.

For the 2025 tax year, the maximum AGI limits are $79,000 for married couples filing jointly; $59,250 for heads of household; and $39,500 for singles and married individuals filing separately. Income beyond these maximums disqualifies you from claiming the credit.

Below are the credit rates and AGI thresholds that apply to the different filing statuses for tax years 2024 and 2025.

Who Is Eligible?

To be eligible for the saver’s tax credit, an individual must be at least 18 years old by the end of the applicable tax year and cannot be claimed as a dependent on another’s tax return. Also, they may not enroll as a full-time student during any part of five calendar months (not necessarily consecutive) during the tax filing year.

The Effect of the Saver’s Tax Credit

Claiming the saver’s tax credit when contributing to a retirement plan can reduce an individual’s income tax burden in two ways. First, the contribution to the retirement plan qualifies as a tax deduction. As a bonus, the saver’s tax credit reduces the actual taxes owed, dollar for dollar.

Consider the following examples:

Barbara is married and works in a clothing store as a clerk. She earned $38,000 in 2024. In addition, she contributed $1,000 to her IRA. Her husband, who is unemployed, had zero earnings. After deducting her IRA contribution, the AGI shown on her joint return is $37,000. In this case, Jill is entitled to claim a 50% credit of $500 ($1,000 × 0.50) for that IRA contribution.

For tax year 2025, if Barbara earns $42,000 (her husband remains unemployed) and contributes $2,000 to her IRA, her AGI on her joint return would be $40,000. That means she can claim a 50% credit of $1,000 ($2,000 × 0.50).

How to Claim the Saver’s Tax Credit

Taxpayers who contribute to qualified employer-sponsored retirement plans, IRAs, or ABLE plans are required to complete IRS Form 8880 to claim the saver’s tax credit.

Those whose income does not exceed the limits for their tax filing status can use this form to report their and their spouse’s total contributions to claim the credit.

You also enter your adjusted gross income to determine the amount of your credit. Once calculated, you must enter the credit amount on Form 1040 and then file Form 8880 with your return.

Important

The saver’s tax credit was initially made available for tax years 2002 to 2006 under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). It became permanent under the Pension Protection Act of 2006 (PPA).

When Are Retirement Savings Not Eligible?

Any money contributed to a retirement account that exceeds the allowable limit must be divested from the account within a specific time frame. The returned portion of the contribution is not eligible for the saver’s tax credit.

Similarly, if an individual changes jobs and consequently rolls money over from one retirement account into another—say, from an employer-sponsored 401(k) to a traditional IRA—then that contribution is likewise ineligible for the saver’s tax credit.

How Can I Get the Saver’s Tax Credit?

To be eligible for the saver’s tax credit, you must be at least 18 years old, not a full-time student during any part of five calendar months (not necessarily consecutive) during the tax filing year, and not claimed as a dependent on another’s tax return. Your adjusted gross income (AGI) must not exceed the saver’s tax credit limit for your filing status, and you must have made contributions to a qualified retirement or ABLE plan for the tax filing year. To claim the credit, file Form 8880 with your tax return.

Who Qualifies for the Saver’s Tax Credit?

The saver’s tax credit is designed to help people with modest incomes save for retirement. It does this by deducting from their income tax bill some portion of the amount they contribute to retirement accounts. To qualify, your AGI must fall below a certain maximum amount.

For the 2024 tax year, the maximum income limits were $76,500 for married couples filing jointly; $57,375 for heads of household; and $38,250 for singles and married individuals filing separately.

For the 2025 tax year, the maximum income limits are $79,000 for married couples filing jointly; $59,250 for heads of household; and $39,500 for singles and married individuals filing separately.

How Much Is the Saver’s Tax Credit?

The saver’s tax credit is 10%, 20%, or 50% of a contribution to a qualified retirement plan (QRP). The maximum contribution amount that qualifies is $2,000 ($4,000 for married couples filing jointly). The credit cannot exceed $2,000 for married couples filing jointly or $1,000 for single filers.

The Bottom Line

The saver’s tax credit can effectively boost an individual’s retirement savings power. Those who qualify for this credit and don’t capitalize on this opportunity are squandering a simple way to add significant value to their nest eggs. So be sure to check it out when you prepare your tax return.

Correction—Feb. 12, 2025: This article has been corrected to state that an individual may not be a full-time student during any part of five calendar months (not necessarily consecutive) during the tax filing year to be eligible for the saver’s tax credit.

It’s important to understand the tax implications

Fact checked by Timothy Li
Reviewed by Marguerita Cheng

A qualified domestic relations order (QDRO) is a court order that divides the assets that are in certain retirement plans, including 403(b)s and 401(k)s. Before using the money to buy a house, you should first consider the tax implications.

Key Takeaways

• A qualified domestic relations order (QDRO) is a court order used to divide certain retirement-specific assets during a divorce.
• Assets distributed from a qualified plan under a QDRO are exempt from the 10% early withdrawal penalty.
• Any money distributed directly to an ex-spouse will be subject to mandatory withholding tax.

Can You Use a QDRO to Buy a House?

Funds distributed from a qualified plan under a QDRO can be used to buy a home, but you should understand the payment options and tax implications.

Assets distributed from a qualified plan under a QDRO are exempt from the usual 10% early withdrawal penalty set by the Internal Revenue Service (IRS).

Recipients can opt to have a portion of the amount processed as a direct rollover to their traditional individual retirement account (IRA) and the balance paid to them to buy a home. The amount processed as a direct rollover to an IRA will not be subject to withholding tax.

Important

Any amounts that you receive directly (instead of rolling over to a retirement plan) will be subject to mandatory withholding tax. This withholding can include 20% for federal taxes held by the plan and an additional amount for state taxes, depending on the state.

Distribution Options

Assets can be rolled over to a traditional IRA and have the distributions paid over time. Amounts paid to recipients for at least five years or until age 59½, whichever is longer, are exempt from the 10% early-distribution penalty, provided the payments meet certain requirements.This option is commonly referred to as substantially equal periodic payments or 72(t) distributions.

To convert the assets to a Roth IRA, beneficiaries must first roll over the funds to a traditional IRA. The funds can then be converted from the traditional IRA to the Roth IRA. However, taxes will be owed on the converted amount for the year the conversion occurs. Then, in retirement, withdrawals will be penalty- tax-free, as long as you’re at least 59 ½ years old and have had the Roth account for at least five years.

Warning

Some qualified retirement plans will not distribute assets under a QDRO until the plan participant—in this case, a former spouse—experiences a triggering event, such as reaching retirement age or leaving an employer. Plans may also consider the QDRO a triggering event.

Are There Exceptions to the 10% Early Withdrawal Penalty for IRAs and 401(k)s?

When an individual withdraws from an IRA or defined-contribution retirement plan before age 59½, these early distributions trigger a 10% early withdrawal tax unless an exception applies. Some exceptions include paying for qualified medical expenses or higher education costs. For more exceptions, visit the IRS website.

Which Retirement Plans Are Subject to a QDRO?

A qualified domestic relations order (QDRO) is a court order used to divide specific types of retirement plans, including qualified plans, such as 401(k) and 403(b) plans. A QDRO must comply with the Employee Retirement Income Security Act (ERISA). ERISA provides a regulatory framework for employer-sponsored retirement plans to protect participants and their beneficiaries. IRAs are not subject to ERISA and are divided using a “transfer incident to divorce.”

Can There Be Additional Beneficiaries Named on a QDRO?

Other than an ex-spouse, dependents may qualify to receive the ordered benefits. In such instances, the alternate payee is a minor or is determined to be legally incompetent. The order can require the benefit plan to make a payment to an individual with legal responsibility for that payee. This can include a guardian or trustee who serves as the agent of the individual.

The Bottom Line

Retirement assets need to be addressed separately during divorce proceedings. Although money can be disbursed to help pay for the purchase of a home, you should consider how and when to use these funds when considering tax penalties.

Fact checked by Stella Osoba

Picking growth stocks with the highest upside potential isn’t easy. Want to know how Wall Street’s top minds spot tomorrow’s biggest winners? Goldman Sachs Group, Inc. (GS) has a surprisingly simple method: find companies that can consistently grow their sales by at least 10%. They call it the “Rule of 10,” and in 2025, 21 companies in the S&P 500 make the cut, including some of the fast-growing companies that we discuss below.

Key Takeaways

• Goldman Sachs created the “Rule of 10” to identify the next wave of stocks poised to soar in value.
• To pass the test, companies must consistently generate sales growth of 10% and be capable of continuing to do so in the future.
• In early 2025, 21 S&P 500 stocks meet Goldman’s revenue criteria.
• Investment decisions shouldn’t just be based on the results of one stock screen.

What Is the Rule of 10?

Goldman Sachs figured a good way to identify the stocks with the most potential to outperform the S&P 500 was to analyze what made today’s biggest winners—the so-called “Magnificent Seven” made up of Alphabet Inc. (GOOGL), Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Meta Platforms, Inc. (META), Microsoft Corporation (MSFT), NVIDIA Corp. (NVDA), and Tesla, Inc. (TSLA)—so successful and popular. Armed with that information, the bank’s analysts could then build a screen that reveals the future growth engines of the stock market.

The name of this screen is the “Rule of 10.”

How the Rule of 10 Works

To pass the test, companies must meet the following conditions:

• Be in the S&P 500 Index.
• Have grown revenues by at least 10% in each of the past two years.
• Be expected to grow sales by at least 10% in the present year, the next fiscal year, and the fiscal year after that.

Stocks that Meet the Rule of 10 Criteria

We screened the S&P 500 for companies with at least 10% revenue growth in 2022 and 2023 (the previous years) and forecasted sales growth of at least 10% in 2024, 2025, 2026, and 2027. The following stocks, as of Jan. 28, 2025, passed the test.

How Can Investors Find the Rule of 10 Stocks?

The stocks that pass the “Rule of 10” test are subject to change as years pass and revenue growth projections are adjusted by analysts. If you want to see which stocks Goldman thinks have a decent chance of outperforming the market in the future, you’ll need to input the criteria mentioned above into a screening tool.

It’s also possible to gather the relevant data for each stock in the S&P 500, but that would take much longer.

Note

Alphabet, Amazon, Synopsys Inc. (SNPS), Visa Inc. (V), and Intuitive Surgical (ISRG) were among the popular firms with investors that narrowly missed out.

The Bottom Line

Goldman Sachs’s “Rule of 10” aims to identify the next wave of S&P 500 stocks capable of delivering the most capital appreciation by focusing on past and future revenues. It’s a stock screen, which means it’s designed to be a starting point for generating ideas—not a final list for entering investment orders today.

Essential Strategies for Reducing Your Capital Gains Tax

Selling a rental property can be a real headache. The first thing that likely comes to mind for owners is a big influx of cash and fewer responsibilities. However, there are also many hurdles to navigate, including being hit with a potentially big tax bill.

Fortunately, with the right help, there are ways to minimize your taxes. In this article, we explain five of the most effective methods.

Key Takeaways

• Capital gains tax can significantly impact the profits from selling a rental property.
• Make sure you sell your rental property after at least a year of ownership and, if possible, sell when your income is lowest.
• Other money-saving tips include converting your rental property to a primary residence, deducting as many expenses as possible, and offsetting gains with losses.
• If you want to replace the rental property, consider a 1031 exchange.
• Professional tax advice is crucial for personalized and legally compliant tax strategies.

Understanding Capital Gains Tax on Rental Properties

When you sell an asset for more than it costs, you are liable for capital gains tax. The asset could be shares in a company, a piece of art, jewelry, a car, or property you rented out.

Suppose you bought a rental property for $300,000 and sold it for $400,000. You could be taxed on the profit made, which is $100,000. If you had owned the property longer than a year, you would most likely fall under the criteria for the capital gains rate of 15%, making the taxes due in this example $15,000.

Short vs. Long-Term Capital Gains

Capital gains are categorized as either short-term or long-term. If you sell an asset for a profit within a year of buying it, this would be considered a short-term capital gain. Meanwhile, if you sell the asset for a profit after more than a year, it is a long-term capital gain.

Short-term capital gains are taxed as regular income at a rate between 10% and 37%, depending on the amount of these and other earnings.

Long-term capital gains are taxed at slightly more favorable rates that range from 0% to 20%, depending on your taxable income.

Strategies To Minimize Capital Gains Tax

Here are some of the more effective strategies to reduce, defer, or even eliminate your capital gains taxes when selling a rental property.

Don’t Sell Within the First Year

An obvious way to lower your capital gains taxes is to sell your rental property after at least a year of ownership to get the long-term rates.

Convert the Rental Property to Your Primary Residence

If you can live in the property for two years before selling it, you could register it as a primary residence and pay less or nothing in capital gains taxes.

Primary residences receive preferential tax treatment. According to Section 121 of the Internal Revenue Code (IRC), profits of up to $250,000 for those who are single and up to $500,000 for those married and filing jointly are not taxed.

To qualify for this exemption, you must have owned and lived in the property for at least two of the five years before the sale. (You can’t use this exemption more than once every two years).

“Moving into your investment property could allow you to sell your current primary home right away,” said Scott Westfall, a real estate broker and consultant. “After two years, you can then sell your rental property and avoid paying capital gains tax on most, if not all, of the profit from that sale as well.”

Taking Part in Section 1031 Exchanges

If you plan to continue investing in rental properties, a 1031 exchange is worth looking into. Named after Section 1031 of the IRC, it allows investors to postpone paying capital gains tax on rental properties by reinvesting the proceeds in like-kind property.

You’ll need to move fast to qualify for this benefit. After selling the rental property, you have 45 days to choose a new property and six months to complete the transaction. That essentially means you should start looking for a replacement property before selling the old one.

Also, bear in mind that the new property must be of equal or greater value and that the funds raised from the old property must be held in escrow by a qualified intermediary until the replacement property is bought.

Sell When Your Income Is Lowest

The rate of capital gains taxes owed depends on your overall taxable income. As such, it makes sense, if possible, to sell rental property in years when you earn less.

If your income fluctuates, consider selling your property in a year when you’re taxes are likely to be lower. Alternatively, if you’re nearing retirement, it could make sense to hold off selling, assuming your retirement income is lower.

Tax-Loss Harvesting

Tax-loss harvesting involves selling investments at a loss to offset capital gains on investments that went up in value.

Here’s an example: Assume you are set to sell your rental property at a $100,000 profit and also happen to have an unrealized loss of $25,000 in an investment you are keen to exit. If you sell the property and the poorly performing investment in the same tax year, your total taxable capital gain would be $75,000 ($100,000 – $25,000).

There are limits on tax-loss harvesting. If your capital losses exceed your gains in a tax year, not all of those losses can necessarily be applied to your tax bill. If your losses are greater than your capital gains, the maximum you can deduct from your total income is $3,000 per year, or $1,500 if married filing separately. Any unused losses, though, can be carried forward to later tax years.

Deduct Expenses

Another way to reduce capital gains tax liabilities is to deduct as many expenses as possible. The IRS permits various deductions on rental property. Qualified expenses, such as mortgage interest payments, maintenance fees, and insurance, can lower your tax bill. You can also use depreciation, which allows you to deduct the rental property’s cost over a set period of time.

When it’s time to sell, you can deduct the costs for offloading your property from your reported capital gain. That includes legal, real estate, and advertising fees as well as expenses to get the property ready for sale.

“You calculate capital gains by subtracting your basis from the sale proceeds of the property,” said Kevin Amolsch, president of Pine Financial Group. “Your basis starts at what you paid for the property when you purchased it. Any depreciation reduces this while improvements increase it.”

Your capital gains tax bill can also be reduced by documenting how improvements and renovations you paid for helped boost the property’s value.

“The higher the basis, the lower the capital gains taxes you’ll need to pay,” Amolsch said. “So be sure to keep track of any improvements made to your properties.”

Professional Advice

You might be tempted to try and save a few dollars by reading articles like this and then forgoing the help of a professional. Doing so could end up costing you more in the long run.

Calculating capital gains on rental property, determining the best ways to lower these liabilities, and then executing these strategies can be complex. For the best results, it’s wise to seek the help of a licensed tax advisor experienced in these sales.

The Bottom Line

Holding the property for more than a year, converting it to a primary residence, utilizing section 1031 exchanges, selling when your income is lowest, tax-loss harvesting, and deducting expenses are among the more effective ways to keep more of the profits when offloading rental properties. Capital gains taxes can sting. However, with the help of a lawyer or tax advisor and these strategies, they can be mitigated, delayed, or perhaps avoided altogether.

Here’s how to do the math—several different ways—to decide what works best

Reviewed by Margaret James
Fact checked by Suzanne Kvilhaug

How Much Should You Save for Retirement?

The primary savings vehicle for most Americans these days is a 401(k) plan. Traditionally, retirees have been able to count on Social Security—and they still can—but the long-term outlook is complicated. Besides, Social Security is designed to cover only 40% of what you’ll need in retirement. The rest is up to you.

To know how much to set aside in a 401(k), you’ll need to know how much you’ll need to live on per month in retirement. You’ll also need to consider your current age, your savings, your projected retirement age, and an estimated market return level, such as 8%.

Key Takeaways

• Take rules of thumb with a grain of salt—such as the 10% rule for retirement savings and determining the percentage of bonds in your asset mix by your age.
• You should include your current age, current savings levels, and estimated retirement age in your calculations. Other primary inputs include estimated market return levels, such as the growth rates of stocks, bond interest rates, and inflation rates over the long term.
• Use an online retirement calculator to help you see how altering your input translates into a higher or lower retirement nest egg.

Set a Monthly Savings Goal

To decide how much to save, you first need to have a retirement goal in mind. You’ll need to calculate how much you’ll need to live on per year or per month. To do that, track your current spending.

One rule of thumb is that in retirement, you’ll need 80% of what you currently spend. So if you currently live on $7,500 per month, you’d need $6,000 per month in retirement. (A word of caution, however: not all retirees can follow the 80% rule. With travel, health care, and other expenses, some retirees find that they spend as much as they did before they retired, or even more.)

Determine Your Best Savings Rate

One rule of thumb is the 10% rule: some experts say that saving 10% of your annual pre-tax salary is enough. Others disagree, saying that 15% or 20% is a better target.

A higher rate may be more appropriate for those who didn’t start saving in their 20s and are now trying to catch up.

Employers generally do match some of what their employees contribute to a 401(k), which can help employees reach a double-digit savings rate.

Estimate Market Returns

Real returns on U.S. stocks have averaged around 7% over the past century. Real bond return levels have been much lower at 2%, while returns on short-term funds have been around 1%.

Clearly, any asset growth will have to rely on stocks and a diversified portfolio of similarly risky assets such as venture capital, real estate, or private equity.

A common rule regarding asset mix is that the percentage an individual should invest in bonds is equal to their current age. Although this allows for a gradual progression to living off interest income at retirement, there is little need for a 20-year-old, who has many decades to ride out stock market volatility in pursuit of real returns, to have even 20% invested in bonds.

Use a Retirement Calculator

Many websites, including AARP, provide retirement calculators to help you enter and tweak the key variables to come up with annual savings goals. Using AARP’s 401(k) calculator and the inputs listed below, here is a summary of potential savings levels from when someone starts working to when they reach retirement.

Primary inputs include a modest starting 401(k) balance of $1,000, 22 as the age at which the employee starts working, a starting salary of $40,000 that grows at 3% per year (roughly the projected annual inflation rate), a 10% contribution rate (or initially at $4,000), a retirement age of 67, and annual portfolio return of 8% per year. Additionally, since an employer match is common, it has been figured in with a projection that it matches half of the first 6% the employee contributes.

Important

When you use an online retirement calculator, the value of your employer’s matching contribution to your 401(k) becomes abundantly clear. Make sure you contribute enough to get the full match.

With these inputs, including a disciplined contribution rate and steady average market returns for more than four decades, this worker would have a substantial nest egg at age 66 with a total account balance of nearly $3.1 million.

You can see why an employer match is a big deal, because without it, the ending balance would be $2.4 million.

With the employer match, the balance would exceed six figures when the employee hit age 32, surpass a half million by age 46, and pass a million by age 53. By age 61, the balance would exceed $2 million.

You can tinker with online calculators like this one to see how changing your inputs—age, salary, contribution rate, portfolio return rate, and more—will alter the amount you can expect to have when you retire.

What Is the 4% Rule?

The 4% rule is a safe withdrawal rate for retirement savings. It states that you can withdraw 4% of your nest egg the first year, and then every year after that, withdraw the same dollar amount (adjusted for inflation). This will sustain you for three decades.

What Is the Median Retirement Savings?

The median retirement savings for Americans is $64,000. This means that half of Americans saved more than this, and half saved less.

How Many People Are Saving for Retirement?

Only about half (54.3%) of Americans had a defined-contribution retirement plan, such as a 401(k), or an individual retirement account (IRA) as of 2022.

The Bottom Line

Setting aside as much money as you can and investing it prudently are two conditions generally under your control as a saver. Of course, you also need to live within your means and either stay current on financial markets or hire a trusted investment advisor.

There are a number of factors to consider

Reviewed by Caitlin Clarke
Fact checked by Katrina Munichiello

If you’re looking to buy a home, it’s important to understand how much you can afford to pay. A general guideline for the mortgage you can afford is 200% to 250% of your gross annual income. However, the specific amount you can afford to borrow depends on several factors, not just what a mortgage lender is willing to lend you. You need to evaluate your finances, preferences, and priorities. Here is everything you need to consider to determine how much you can afford.

Key Takeaways

• The general rule is that you can afford a mortgage that is 2x to 3x your gross income.
• Total monthly mortgage payments are typically made up of four components: principal, interest, taxes, and insurance.
• Your front-end ratio is the percentage of your annual gross income that goes toward paying your mortgage, and in general, it should not exceed 28%.
• Your back-end ratio is the percentage of your annual gross income that goes toward paying your debts, and in general, it should not exceed 43.

How Much of a Mortgage Can I Afford?

Most prospective homeowners can generally afford to finance a property whose mortgage is between two and three times their annual gross income. Under this formula, a person earning $100,000 per year can only afford a mortgage of $200,000 to $250,000. However, this calculation is only a general guideline.

Ultimately, when deciding on a property, you need to consider several additional factors. First, it’s a good idea to understand what your lender thinks you can afford and how it arrives at that estimate.

Second, you need to have some personal introspection and figure out what type of home you are willing to live in if you plan on living in the house for a long time and what other types of consumption you are ready to forgo—or not—to live in your home.

Important

While real estate has traditionally been considered a safe long-term investment, recessions and other disasters (like the 2020 economic crisis) can test that theory—and make would-be homeowners think twice.

How Do Lenders Determine Mortgage Loan Amounts?

While each mortgage lender maintains its own criteria for affordability, your ability to purchase a home (and the size and terms of the loan you will be offered) always depends mainly on the following factors.

Many factors go into the mortgage lender’s decision on homebuyer affordability, but they boil down to income, debt, assets, and liabilities. A lender wants to know how much income an applicant makes, how many demands there are on that income, and the potential for both in the future—in short, anything that could jeopardize its ability to get paid back.

Your income, down payment, and monthly expenses are generally base qualifiers for financing, while your credit history and score determine the rate of interest on the financing itself.

Gross Income 

This is the level of income a prospective homebuyer makes before taking out taxes and other obligations. This is generally deemed your base salary plus any bonus income and can include part-time earnings, self-employment earnings, Social Security benefits, disability, alimony, and child support.

Front-End Ratio

Gross income plays a vital part in determining the front-end ratio, also known as the mortgage-to-income ratio. This ratio is the percentage of your yearly gross income that can be dedicated toward paying your mortgage each month. The total that makes up your monthly mortgage payment consists of four components, known as principal, interest, taxes, and insurance (PITI). If required by your mortgage, the insurance portion includes property insurance and private mortgage insurance (PMI).

A good rule of thumb is that the front-end ratio based on PITI should not exceed 28% of your gross income. However, many lenders let borrowers exceed 30%, and some even let borrowers exceed 40%.

Back-End Ratio

Also known as the debt-to-income ratio (DTI), it calculates the percentage of your gross income required to cover your debts. Debts include credit card payments, child support, and other outstanding loans, such as your car loan and student loan.

In other words, if you pay $2,000 each month in debt services and you make $4,000 each month, your ratio is 50%—half of your monthly income is used to pay the debt.

However, a 50% DTI ratio isn’t going to get you that dream home. Most lenders recommend that your DTI not exceed 43% of your gross income. To calculate your maximum monthly debt based on this ratio, multiply your gross income by 0.43 and divide by 12.

Your Credit Score

If one side of the affordability coin is income, then the other side is your debt. Mortgage lenders have a formula to determine the level of risk of a prospective home buyer. The formula varies but is generally determined by using the applicant’s credit score.

Applicants with a low credit score can expect to pay a higher interest rate, also referred to as an annual percentage rate (APR), on their loan. If you want to buy a home soon, pay attention to your credit reports.

Be sure to keep a close eye on your reports. If there are inaccurate entries, it will take time to get them removed, and you don’t want to miss out on that dream home because of something that is not your fault.

The 28%/36% Rule

The 28%/36% rule is a heuristic used to calculate the amount of housing debt one should assume. According to this rule, a maximum of 28% of one’s gross monthly income should be spent on housing expenses and no more than 36% on total debt service (including housing and other debt such as car loans and credit cards). Lenders often use this rule to assess whether to extend credit to borrowers. Sometimes the rule is amended to use slightly different amounts, such as 29%/41%.

How to Calculate a Down Payment Amount

The down payment is the amount that the buyer can afford to pay out-of-pocket for the residence, using cash or liquid assets. Lenders typically demand a down payment of at least 20% of a home’s purchase price, but many let buyers purchase a home with significantly smaller percentages. Obviously, the more you can put down, the less financing you’ll need, and the better you look to the bank.

For example, if a prospective homebuyer can afford to pay 10% on a $100,000 home, the down payment is $10,000, which means the homeowner must finance $90,000.

Besides the amount of financing, lenders also want to know the number of years for which the mortgage loan is needed. A short-term mortgage has higher monthly payments but is likely less expensive over the duration of the loan.

Homebuyers need to come up with a 20% down payment to avoid paying private mortgage insurance.

Personal Considerations for Homebuyers

A lender may say that you can afford a considerable estate, but can you? Remember, the lender looks primarily at your gross pay and other debts. The problem with using gross income is simple: You factor in as much as 30% of your paycheck—but what about taxes, FICA deductions, and health insurance premiums? Also consider your pre-tax retirement contributions and college savings, if you have children. Even if you get a refund on your tax return, that doesn’t help you now—and how much will you get back?

That’s why some financial experts feel it’s more realistic to think in terms of your net income and that you shouldn’t use any more than 25% of your net income on your mortgage payment. Otherwise, while you might be able to pay the mortgage monthly, you could end up house-poor.

The costs of paying for and maintaining your home could take up such a large percentage of your income—far and above the nominal front-end ratio—that you won’t have enough money left to cover other discretionary expenses or outstanding debts or to save for retirement or even a rainy day. Whether you should be house-poor or not is mostly a matter of personal choice; getting approved for a mortgage doesn’t mean you can afford the payments.

Pre-Mortgage Considerations

In addition to the lender’s criteria, consider the following issues when contemplating your ability to pay a mortgage:

1. Income

Are you relying on two incomes to pay the bills? Is your job stable? Can you easily find another position that pays the same, or better, wages if you lose your current job? If meeting your monthly budget depends on every dime you earn, even a small reduction can be a disaster.

2. Expenses

The calculation of your back-end ratio will include most of your current debt expenses, but you should consider future costs like college for your kids (if you have them) or your hobbies when you retire.

3. Lifestyle

Are you willing to change your lifestyle to get the house you want? If fewer trips to the mall and a little tightening of the budget don’t bother you, applying a higher back-end ratio might work out fine. If you can’t make any adjustments or already have multiple credit card account balances—you might want to play it safe and take a more conservative approach in your house hunting.

Personality. No two people have the same personality, regardless of their income. Some people can sleep soundly at night knowing that they owe $5,000 per month for the next 30 years, while others fret over a payment half that size. The prospect of refinancing the house to afford payments on a new car would drive some people crazy while not worrying others at all.

Costs Beyond the Mortgage

While the mortgage is undoubtedly the most considerable financial responsibility of homeownership, there are many additional expenses, some of which don’t go away even after the mortgage is paid off. Smart shoppers would do well to keep the following items in mind:

• Property Taxes: Understanding how much you owe is an important part of your budget. The city, township, or county establishes your property tax based on your home, lot size, and other criteria, including local real estate conditions and the market. The amount varies by state, and some states boast lower property taxes than others. For example, New Jersey’s was an average of 2.08% in 2024, but Alabama’s was 0.36%. You will always have to account for paying property tax, even when your mortgage is paid off in full.
• Home Insurance: Every homeowner needs home insurance to protect their property and possessions against natural and human-made disasters, like tornados or theft. If you buy a home, you will need to price out the appropriate insurance for your situation. Most mortgage companies won’t let you purchase a home without coverage for the purchase price. You may need to show proof of home insurance to be approved by your mortgage lender.
• Maintenance: Even if you build a new home, it won’t stay new forever, nor will those expensive appliances. The same applies to the home’s roof, furnace, driveway, carpet, and even the paint. If you are house-poor when you take on that first mortgage payment, you could find yourself in a difficult situation if your finances haven’t improved by the time your home requires significant repairs.
• Utilities: Heat, insurance, electricity, water, sewage, trash removal, cable television, and telephone services cost money. These expenses are not included in the front-end ratio and they aren’t calculated in the back-end ratio. Nevertheless, they are unavoidable for most homeowners. Consider that a bigger house means higher utility bills due to heating and cooling energy needs to condition the bigger space. Many people overlook that when they see a big charming home.
• Association Fees: Many condominiums and coops and specific gated neighborhoods or planned communities assess association fees. They can be less than $100 per year while others are several hundred dollars per month. Some communities include lawn maintenance, snow removal, a community pool, and other services. Some fees are only used for administration costs. It’s important to remember that while an increasing number of lenders include association fees in the front-end ratio, these fees are likely to increase over time.
• Furniture and Decor: Before you buy a new house, take a good look at the number of rooms that will need to be furnished and the number of windows that will require covering.

Tips for Buying a Home

To help ensure that you can afford your home and maintain it over time, there are some smart measures you can take. First, save up a cash reserve that exceeds your down payment and keep it tucked away in case you lose your job or can’t earn income. Having several months of mortgage payments in emergency savings lets you keep the house while you look for new work.

You should also look for ways to save on your mortgage payments. While a 15-year mortgage will cost you less over the loan’s life, a 30-year mortgage will feature lower monthly payments, which may make it easier to afford month-to-month. Certain loan programs offer reduced or zero down payment options such as VA loans for veterans or USDA loans for rural properties.

Finally, don’t buy a bigger house than you can afford. Do you need that extra room or the finished basement? Does it need to be in this particular neighborhood? If you are willing to compromise a bit on things like this, you can often score lower home prices.

How Much of a Mortgage Can I Afford Based on My Salary?

The amount of a mortgage you can afford based on your salary often comes down to a rule of thumb. For example, some experts say you should spend no more than 2x to 2.5x your gross annual income on a mortgage (so if you earn $60,000 per year, the mortgage size should be at most $150,000). Other rules suggest you shouldn’t spend more than 28-29% of your gross income per month on housing.

What Does It Mean to Be House Poor?

House poor is a situation where most of your wealth is tied up in your house and much of your income goes toward servicing the mortgage debt and related expenses. An example would be if you had $100,000 in savings and used all of it to finance a $500,000 property with a $2,500 monthly mortgage payment when your net income is $3,000 per month.

Such a situation can give the illusion of economic prosperity but quickly unravel to foreclosure if things turn sour.

How Much Debt Can I Already Have and Still Get a Mortgage?

The amount of debt you can have will depend on your income, and in particular your debt-to-income (DTI) ratio. Generally having a DTI of 30% or less is the rule of thumb going into the mortgage application process, and with the mortgage it shouldn’t then exceed 43% on the back end.

The Bottom Line

The cost of a home is the single largest personal expense most people will ever face. Before taking on such an enormous debt, take the time to do the math. After you run the numbers, consider your situation and think about your lifestyle—not just now but into the next decade or two.

Before you purchase your new home, consider not only what it costs you to buy it but how your future mortgage payments will impact your life and budget. Then, get loan estimates for the type of home you hope to buy from several different lenders to get real-world information on the kinds of deals you can get.

Warning

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau (CFPB) or with the U.S. Department of Housing and Urban Development (HUD).

Over the years, Warren Buffett has repeatedly called one deal his worst investment ever: the 1993 purchase of Dexter Shoe Company for $443 million worth of Berkshire Hathaway Inc. (BRK.A) stock. As of February 12, 2025, those same shares would be worth $17.87 billion—a staggering loss that Buffett has said “deserves a spot in the Guinness Book of World Records.”

While Berkshire Hathaway shares soared in value over the last three decades, those for Dexter Shoe collapsed, making it not only a bad investment but what Buffett says was a “monumentally stupid decision” in how the deal was structured. Below, we take you through why.

Key Takeaways

• Buffett’s Dexter Shoe Company purchase demonstrates how paying with company stock instead of cash can magnify losses dramatically over time—the $443 million in Berkshire stocks he traded in 1993 would be worth about $17.87 billion today.
• The investment failed because Buffett misread Dexter’s competitive advantage, not realizing that overseas competition would quickly erode the company’s market position.
• Ironically, the scale of the loss is measured by Berkshire Hathaway’s incredible success—which was built on Buffett’s general ability to avoid such mistakes and identify those firms with sustainable competitive advantages.

What Went Wrong With Dexter Shoe

When Buffett bought Dexter Shoe Company in 1993, the Maine-based company seemed to have everything the famed value investor looks for: It was profitable, well-managed, and seemed to have what Buffett calls a “moat,” a sustainable advantage over rivals. American-made shoes, particularly Dexter’s high-quality casual and dress footwear, were also getting premium prices and had customer loyalty at the time.

Mistake No. 1: Misreading the Competitive Landscape

Buffett had missed a crucial shift happening in the industry. Foreign factories, particularly in China, were rapidly improving their quality while keeping their labor costs much lower than their American peers. Within just a few years, overseas competitors began flooding the U.S. market with similar shoes at much lower prices.

“What I had assessed as a durable competitive advantage vanished within a few years,” Buffett wrote in his 2007 letter to shareholders. By 2001, Dexter had closed its last Maine factory, and the brand was eventually folded into H.H. Brown, another Berkshire-owned shoe company.

Mistake No. 2: Paying with Berkshire Stock

Making the acquisition was only half the problem. Buffett’s bigger error was paying for Dexter with Berkshire Hathaway stock instead of cash. The 25,203 shares he used to buy Dexter were worth $433 million in 1993 (or about $949.20 million today)—but those same shares would be worth $17.87 billion today.

The lesson to take from this? “Too often CEOs seem blind to an elementary reality: The intrinsic value of the shares you give in an acquisition must not be greater than the intrinsic value of the business you receive,” Buffett said.

Note

In late 2024, the local paper where Dexter Shoe was located caught up with those benefiting from owner Harold Alfond’s sale. Even after splitting her father’s gains from the deal with three brothers, Susan Alfond of Scarborough, Maine, still had enough to make her the wealthiest person in the state, about $3.3 billion, according to Forbes.

The Bottom Line

Warren Buffett says he violated two of his core principles in the Dexter Shoe deal: never pay with undervalued stock and always ensure a business has a sustainable competitive advantage. While Berkshire Hathaway’s subsequent success has made this mistake look far worse in dollar terms, BRK.A’s share price is only what it is today because Buffett has been disciplined in buying what he calls excellent businesses at fair prices, not fair businesses at excellent prices. “The best thing that happens to us is when a great company gets into temporary trouble,” Buffett has said repeatedly.

They’re helpful in some cases but also come with risks

Reviewed by Lea D. Uradu

Television commercials for reverse mortgages commonly extol the benefits of a guaranteed tax-free income for homeowners aged 62 and older. However, reverse mortgages can be expensive and, in some cases, put a person’s home at risk. You may also become ineligible for certain government benefits, put your family members at risk for eviction, and leave your heirs with more hassles after you die.

Key Takeaways

• A reverse mortgage can provide a lump sum of cash or a regular income stream to homeowners over age 62.
• There are several types of reverse mortgages, the most common being home equity conversion mortgages, which are insured by the federal government.
• Reverse mortgages can be expensive compared to other types of loans.
• They can also put the borrower at risk of foreclosure and losing their home in certain cases.
• A spouse who qualifies may be able to remain in the home if their spouse dies or moves into a nursing home.

What Is a Reverse Mortgage?

A reverse mortgage allows a homeowner with sufficient equity in their home to draw on that equity for income. Unlike a home equity loan or line of credit, which the homeowner has to pay back on a regular schedule, the income from a reverse mortgage need not be paid back until the homeowner leaves the home, sells it, or dies. At that time, the loan balance, interest, and accrued fees must be paid in full, usually with the proceeds from selling the home.

For homeowners with few or no other assets, a reverse mortgage can provide a much-needed income supplement in retirement. It can also help pay for medical bills or other unexpected expenses. However, it has some potential drawbacks worth noting before you apply.

Review our list to compare the Best Reverse Mortgage Lenders.

How Reverse Mortgages Work

The most common type of reverse mortgage is a home equity conversion mortgage (HECM), which is issued through private lenders but insured by the Federal Housing Administration (FHA). These mortgages are available only to borrowers over the age of 62.

Lenders can also issue their proprietary reverse mortgages, often with higher loan limits than HECMs and sometimes without the same age restrictions. In addition, some states and municipalities offer single-purpose reverse mortgages, designated for a specific use, such as home repairs or tax payments.

The amount that a person can borrow depends on different factors, including their age (and that of any co-borrowers), their loan’s interest rate, and the appraised value of their home.

Reverse mortgages can be structured in several ways. The borrower can receive the money as a single lump sum, as a credit line that they can draw on as needed, or in regular monthly payments for a set period or for as long as they live in the home.

While reverse mortgages can be useful in some instances, they also have downsides that anyone who’s considering one needs to be aware of.

Relatively High Fees

Lenders can offer slightly different products under the reverse mortgage banner. But they all charge an assortment of fees, and a reverse mortgage will typically be more expensive than a regular mortgage.

Before taking out a HECM, borrowers must receive counseling from a reverse mortgage housing counseling agency approved by the U.S. Department of Housing and Urban Development (HUD). Typically that will be free or involve a modest fee. The counselor should explain all of the likely costs and how they work.

The following fees apply to HECMs, but other kinds of reverse mortgages will have similar lists of their own.

• Origination fee: With a HECM, the lender can charge either $2,500 or 2% of the first $200,000 of your home’s value, whichever is greater, plus 1% of the amount over $200,000. The fee can’t exceed $6,000.
• Real estate closing fees: As with a regular mortgage, reverse mortgages can rack up different closing costs, including a home appraisal and inspection, title search, recording fees, mortgage taxes, and a credit check of the applicant, among others.
• An initial mortgage insurance premium: This is typically equal to 2% of the home’s value.

Borrowers can pay these upfront costs with their own money or use the loan proceeds to pay for them. In addition, borrowers can expect ongoing expenses, including:

• Interest: The interest on a reverse mortgage accumulates, adding to the amount the borrower or their heirs will have to pay back at the end. Unless the borrower takes the money in a lump sum, the interest rate will be variable, which means it can rise or fall.
• Servicing fees: These monthly fees reimburse the lender for its ongoing costs, such as making payments and processing paperwork. The HECM rules limit these fees to no more than $30 for fixed-rate loans or variable-rate loans that adjust just once a year and no more than $35 for variable loans that adjust monthly.
• Annual mortgage insurance premium: This will be 0.5% of the outstanding loan balance every year. As such, it will rise over time as the borrower draws out more equity.

Again, these numbers apply to HECMs and may be higher or lower with other types of reverse mortgages. Either way, borrowers will be in for a lot of fees, which has been a traditional complaint with these types of loans.

Ineligibility for Certain Government Benefits

In some instances, a reverse mortgage can affect a homeowner’s eligibility for government benefits.

If the homeowner wants to receive Medicaid, the joint federal and state health insurance program for some low-income and elderly Americans, their eligibility is based on their income and assets. Income from a reverse mortgage won’t count against them, but if they receive a lump sum from the reverse mortgage, that will be included among their assets. If their total assets exceed the limit for their state, they will have to spend the money to be eligible.

Money from a reverse mortgage lump sum can affect a person’s eligibility for Supplemental Security Income (SSI), a federal program for low-income individuals. The SSI program also sets limits on assets (which it refers to as resources), currently $2,000 for individuals and $3,000 for couples.

Important

A reverse mortgage will not affect Social Security or Medicare benefits.

Lenders May Foreclose

When homeowners take out a reverse mortgage, they agree to keep the property in good repair and to continue to pay real estate taxes, homeowners insurance premiums, and any association or related fees out of their pockets.

Failure to do so can allow the lender or loan servicer to foreclose on the property and cost the borrower their home, according to the Consumer Financial Protection Bureau (CFPB).

Other Family Members Can Be Evicted

Once the borrower(s) on a reverse mortgage die or leave the home for a certain length of time, the reverse mortgage can become due and payable. In the past, this sometimes meant that a spouse who wasn’t listed as a borrower in the loan agreement (often because they hadn’t reached age 62 when their spouse took out the loan) could be evicted.

Major reforms enacted in 2014 and 2021 for HECMs issued after those dates expanded the protections for some spouses. In particular, those who qualify as eligible non-borrowing spouses can now remain in the home for the rest of their lives.

• Under the 2014 rules, eligible non-borrowing spouses must have been legally married to the borrower when the reverse mortgage closed and remained married to them until the borrower’s death. For couples prohibited by law from marrying before the closing because of their gender, the survivor was eligible if the couple legally married before the death of the borrower and remained married until that person’s death. The non-borrowing spouse must also have lived in the property at the time of the closing and continued to live there as their principal residence.
• The 2021 rules broadened eligibility so if the borrower didn’t die but moved into a nursing home or similar facility, their spouse could remain in the home. Before then, the spouse would have had to pay off the mortgage after one year.

Spouses who don’t meet these requirements must still pay off the loan if they wish to remain in the home. This is also true for other heirs, such as children, who may live there. Otherwise, they will need to sell it.

The good news is that if they can sell it for more money than is needed to pay off the loan, they get to keep the difference. And even if the loan balance exceeds the sale price, they won’t have to make up the difference as long as they sell it for at least 95% of its appraised value. According to the CFPB, the lender uses the proceeds from the sale of the home as payment on the loan while the “rest of the loan is covered by the mortgage insurance that the reverse mortgage borrower paid during the duration of the loan.”

As an alternative, they can simply turn it over to the lender and walk away.

Smaller Inheritances and Greater Hassles for Any Heirs

A reverse mortgage can also deplete much of the homeowner’s wealth, especially if their home is basically all they have, leaving little behind for their heirs.

That said, it is their home to do with as they decide, and it may be better for them to take out a reverse mortgage than to rely on their family for financial assistance. And it is certainly better than having to live out their last years in poverty.

Leaving a home with a reverse mortgage to heirs (other than an eligible spouse) also puts a burden on them. In general, they’ll have 30 days after receiving a due and payable notice from the lender to pay off the debt, either by selling the home, buying it themselves, or signing it over to the lender. However, some lenders will extend that period by up to six months. This can be helpful if an heir wants to keep the home but needs to obtain financing to do so.

What Are Alternatives to a Reverse Mortgage?

Homeowners can also consider a home equity line of credit (HELOC), a home equity loan, or a cash-out refinance to borrow against their home’s equity.

How Much Money Can a Homeowner Get With a Reverse Mortgage?

The amount of money someone can get with a reverse mortgage depends on their age and the age of any co-borrowers, the value of the home, and the interest rate on the loan. The current maximum for a HECM is $1,149,825. Private loans can have higher limits but may also have higher interest rates.

Can a Borrower Cancel a Reverse Mortgage?

A borrower can cancel a reverse mortgage within three days of the loan closing without paying any financial penalties. This is known as “the right of rescission.” 

The Bottom Line

A reverse mortgage can allow an older homeowner to tap the equity that has built up in their home over the years without having to sell it or move out. However, these loans can be expensive and also have some disadvantages for the borrower’s heirs, so it’s worth considering the alternatives.

Fact checked by Suzanne Kvilhaug
Reviewed by David Kindness

We get it—given the state of the world, it may feel weird to start putting money aside for much later in life. In fact, 73% of Gen Z say the current economy makes them hesitant to set long-term goals. Not to mention, making a good living and building your savings is tough, with expenses like housing and essentials getting more and more costly.

Even so, investing in your future is a fundamental practice to ensure you’ll live comfortably down the road. Luckily, some systems and tools can help make the process smoother.

Once you calculate an ideal (and feasible) retirement age, there are a few routes you can take. If your job offers 401(k) benefits, you can aim to save at least 15% of your pretax income—the percentage that many financial advisors suggest.

Key Takeaways

• Starting early and contributing to a 401(k) in your 20s is crucial for long-term financial security.
• Aim to save at least 15% of your pretax income for retirement.
• Take advantage of employer matching contributions to maximize your savings.
• Use the 50/30/20 rule of thumb to determine the amount to contribute to your 401(k).
• Increasing your contributions over time can significantly impact your retirement savings.

In some cases, your employer will match part or all of your contributions, which is essentially a way to double your savings. If you don’t have a 401(k) plan through an employer, you can open an individual retirement account (IRA). We’ll explain.

Understanding 401(k) Contributions

A 401(k) is a retirement savings plan offered by many U.S. employers. As an employee who signs up for a 401(k), you agree to have a percentage of each paycheck paid directly into an investment account, and the employer may match part or all of that contribution. If you have a 401(k), you can choose among several investment options, typically mutual funds.

Taking advantage of a 401(k) plan is smart for a few reasons, one of which is the tax benefits. Your investments are pretax, meaning you keep a higher portion of each paycheck. Taxes and penalties typically apply only if you withdraw funds from your 401(k) before you turn age 59½. You can also deduct any traditional 401(k) contributions from your taxable income, which may reduce the amount you owe in federal taxes.

“It’s like why we buy toilet paper in bulk. A 401(k) is bulk buying,” said Jeanne Sutton, CFP, CPFA, MBA, who specializes in future financial planning. “A bunch of people are banding together and creating an investment account and getting lower pricing for doing that. So in general, a 401(k) should be the first, and for most Gen Z, the only place they have to save right now.”

Factors When Calculating Your Contribution Amount

To understand how much of your paycheck you should aim to invest, you need to consider several factors.

Calculate an Ideal Retirement Age

Start by calculating your ideal retirement age. This is based on your individual goals and circumstances.

There are several retirement calculators that let you adjust numerous factors to help determine how much you need to save. They factor in your current age, target retirement age, annual income, annual retirement savings, expected income increases, etc.

Aim To Save 15% Early in Your Career

While it may seem difficult to balance housing, basic necessities, a social life, school, and hobbies all on the same paycheck, there’s still no time like the present to start—literally. These days, 20-somethings are often not saddled with some larger financial obligations such as dependents and mortgages.

If we’ve learned anything in our 20-something years on earth, it’s that things tend only to get more complicated—the longer you wait, the more you’ll have to put away later in life. It’s smart to start as soon as possible rather than risk running out of money or having to defer retirement.

If you are financially stable—not sweating—you should aim to save about 15% of your annual salary early in your career. The more time you give your 401(k), the more opportunity your contributions have to grow compound interest—essentially, the interest you grow on your interest. 

“We believe that we need a bunch of money to start investing or that we can wait to get started when, in actuality, if we take a relatively small amount of money but allow it to grow and with as much time as possible, that’s the way to do it,” said Tori Dunlap, New York Times bestselling author and founder of HerFirst100k. “So I always tell people that time is more important than the amount of money when it comes to investing.”

Gen Z workers who have been in their 401(k) plan for five years straight saw their balances climb to an average of $29,100 in the third quarter of 2023, according to Fidelity. “With a relatively small amount of money, I can allow it to grow and work harder for me as I progress,” Dunlap said.

Take Advantage of Employer Contributions

Many employers offering a 401(k) plan also provide an employer match, in which the company matches employee contributions up to a certain percentage of their salary. According to Vanguard, the median contribution in 2023, the most recent year for which data is available, was 4%.

Employers have several options for matching 401(k) contributions. They can opt to match employee contributions dollar-for-dollar up to a certain percentage, or match a partial amount, e.g., 50 cents on the dollar up to 4%. Employers can also create a tiered formula, for example contributing 100% of the first 2% of the employee’s contribution and 50% of the next 2%. Some employers also set a dollar cap on the total contribution.

Your employer may also choose to set a vesting schedule for their matching contributions. In this case, you will be entitled to a percentage of the matching contribution after a set number of years of service.

Typically, vesting schedules increase with your tenure at the organization until you are fully vested. For example, you might be 20% vested at two years, 40% vested at three years, and so on, until you’re 100% vested at six years of service.

Important

An employer 401(k) match is free money. Whenever possible, it makes sense to contribute enough to maximize your 401(k) match.

Alternative Options for Savings

If you don’t have a 401(k) package in your role, you still have the option to begin your retirement savings. Opening a Roth or traditional IRA is a great way to allocate a portion of your income and invest it for your future self.

A Roth IRA allows you to contribute post-tax dollars, so there are no immediate tax savings, but once you retire, the amount you paid in and the money it earns over time are both tax free. Conversely, a traditional IRA allows you to contribute a portion of pretax dollars. This reduces your annual taxable income while setting aside money for retirement. You will have to pay taxes when you withdraw this money. Similarly to a 401(k) plan, you should allocate the money in your account to ensure that you’re investing these funds instead of letting them sit.

In fact, Gen Z tends to lean in favor of IRAs over 401(k)s. This could be due to the prevalence of the gig and creator economies. Gen Z investors saw a 63% increase in IRAs year over year, while overall dollar contributions increased 51% in the third quarter of 2023, according to Fidelity.

Applying the 50/30/20 Rule

The golden rule for money management is the 50/30/20 rule. In this framework, you spend 50% of your after-tax paycheck on needs, 30% on wants, and 20% on savings.

It’s intended to help you get in the habit of managing your after-tax income responsibly, especially to have funds on hand for emergencies and retirement. Every household should first prioritize creating an emergency fund in case of layoffs, unexpected medical expenses, or other unforeseen costs.

Needs include:

• Rent or mortgage payment
• Car payment
• Insurance and healthcare
• Grocery
• Minimum debt payments
• Utilities

Wants include:

• New clothing
• Tickets to events
• Eating out
• Vacations and nonessential travel
• The latest gadget

Savings include:

• Creating an emergency fund
• Making contributions to a 401(k) or IRA
• Investing in the stock market
• Setting aside funds to buy property
• Making debt repayments beyond the minimum

Of course, following this framework can be incredibly difficult—and few actually can. As of January 2024, the average monthly personal saving rate for individuals in the United States was just 3.8%. Even if it’s just aspirational for now, keeping this framework in mind will help you set lasting, healthy habits with your money.

Tips To Maximize 401(k) Contributions in Your 20s

Contributing your 401(k) may feel like a luxury in your 20s. You’re just beginning your career and likely have other expenses competing for a share of your entry-level salary including student loans and skyrocketing housing costs.

However, there are ways to fit 401(k) contributions into your budget and begin the habit of saving for your future.

• Start small: Even 1% of your salary will make a difference over time. Given that your 401(k) contribution is probably pre-tax, you may not even notice the difference in your take-home pay.
• Start early: As the saying goes, it’s not timing the market, it’s time in the market. Getting started early will help you maximize the power of compound interest, which will grow your savings over time.
• Aim to meet your employer match: If you have an employer match, take advantage of it. Let that percentage be your initial savings target.
• When you get a raise, your 401(k) gets a raise: Make a commitment to increase your contribution whenever you get a raise, promotion, or new job.

Alternatives to a 401(k)

As mentioned above, IRAs are excellent alternatives to 401(k) plans if you don’t have a benefits package in your role.

Another option is to have your employer match your student loan payments. Under the SECURE 2.0 Act, the Internal Revenue Service (IRS) authorizes linking 401(k) matching contributions to employee student loan repayment.

While this may seem like an excellent option for many, it’s still good to start saving for retirement soon. Any debt repayments should be prioritized by how high the interest level is; if it’s small—say, under 6%—it may be more financially beneficial for you to contribute to a retirement plan than pay off your loans faster.

What Is the Best Age To Start a 401K?

As soon as possible. Unless you’re barely scraping by on every paycheck, you should take advantage of your 401(k) plan immediately.

Can I Withdraw From My 401K in My 20s?

Technically, yes, though it’s not a good idea. If you withdraw before age 59½, you’ll face hefty fees and penalties. However, it’s not impossible: Fidelity says that in the third quarter of 2022, some 2.3% of workers took hardship withdrawal. The top reasons behind this increase were avoiding foreclosure or eviction and paying medical expenses.

What Happens to My 401(K) if I Switch Jobs?

You can roll your 401(k) plan over to your new role. If your new role doesn’t offer a retirement savings plan, you can still roll your 401(k) into an IRA and invest it from there.

The Bottom Line

Contributing to your 401(k) in your 20s will help you maximize the impact of compound interest, giving your money the most time to grow. If you can’t commit to saving 15% of your income right off the bat, start small. Focus on meeting your employer match, if you have one. Over time, you can increase your contribution as you earn more money.

Ultimately, any money you invest in your 401(k) when you’re starting your career is an investment in your future financial security. Best of all, you’ll be building solid money-management habits that will last a lifetime.