Why to Steadily Raise Savings

Even when employees are lucky enough to have a 401(k) plan from their employer, they usually don’t save enough to maintain their lifestyles after they retire. Unfortunately, employers spread the idea that a small, constant savings rate is enough. It isn’t. Steadily raising your savings rate every year helps you avoid struggling to pay for living expenses in your old age.

The Center of Retirement Research analyzed Federal Reserve data and found that of the 60% of Americans near retirement age, most don’t have enough savings to generate even 85% of pre-retirement income every year. Of those over 30 years old, 53% are too far behind on savings to avoid a crunch later when retired.

This is an unfortunate consequence of the sea change over the last several decades where most workers of private large companies in the United States no longer receive pensions. Companies used to support retired workers and their families through a pension payment for as long as they lived in retirement. All of that changed when we began to offer 401 (k) plans, which encouraged employees to save for their old age.

With this change, employees mostly invest their savings in a choice of 401(k) investment options selected by the employer. The Center for Retirement Research data show that many retirees fall short of the savings that they need, even when they do have pension income to bolster their income.

The companies usually set a default target of 3% for the savings rate for pre-tax contributions into 401(k) plans. Some generous companies even matched the first 3% of the employees’ contribution.

That created the first problem for most employees. It set the incorrect expectation that 3% was the ideal percentage for them to meet their goals. Judging by the center’s data, this is surely not so.

The book Save More Tomorrow by Richard Thaler and Shlomo Benartzi discusses practical solutions to improve employee savings. The book is geared toward people responsible for corporate retirement plans, but their suggestions can help participants, as well. They suggest that the savings rate percentage that young employees should target is 4% to 5%. 

So if you are currently just beginning in the workforce and joining a plan, try to increase your saving rate to 5% of your gross income. Over time, the percentage needs to increase to a minimum of 10%, they say. But how can we organize ourselves to achieve this increase in our savings rate?

The authors suggest that, as employees receive salary increases, they should automatically increase the percentage saved in their 401(k) plan. It works because you never adjust your lifestyle to the full salary increase. You never feel like you have to give up money for savings.

Thaler and Benartzi recommend this as a built-in feature of 401(k) plans. Even if your company does not offer automatic escalation, I strongly encourage you to put this into practice for your own retirement.

Delayed gratification is crucial. The future is more important than consumption today. But with this gradual-increase approach, you do not have to give anything up today and just raise the percentage saved in your 401(k) as you receive future pay increases, so you don’t feel the same sense of sacrifice that makes it difficult for some folks.

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Dan Crimmins is the co-founder of Crimmins Wealth Management LLC in Woodcliff Lake, N.J. His websites arewww.CrimminsWM.com and www.RootsofWealth.com.
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