Dr. Daniel Crosby, Ph.D., President, IncBlot Behavioral Finance
Knowledge is power when saving for retirement. Many experts simply advise, “start saving now,” and “save as much as possible.” Yet, fewer than half of all Americans have taken the time to develop an estimate for retirement savings. Which half are you in?
Saving for retirement early is key, but understanding why and to what end are even more important. A National Bureau of Economic Research study on financial literacy and retirement revealed a tool as simple as a low-cost, direct-mail campaign could motivate a recipient to make an average increase of $1,150 in annual contributions.
A further study anchored goal-setting to simple, turn-key retirement communications. Employees at a large technology firm received one of two types of email messages reminding them about the opportunity to adjust their 401(k) contribution rate before the end of the year.
The first group received a generic message reminding them to take advantage of a company match in contributions. The second group received a customized message that tied their personal contribution to a specific outcome: “For example, you could increase your contribution rate by 1% of your income and get more of the match money for which you’re eligible…” The employees received various ‘goal’ percentages. The mention of higher savings goals raised income contributions by as much as 2.2%, while lower or no goals had little to no effect on increasing contributions.
In short, an educated saver will save more and will save for specific reasons.
What’s your end game?
The conscious decision to start saving for retirement is shaped by your goals for retirement living. Your current lifestyle likely influences your expectations for retirement. So, what level of income do you need to maintain a similar lifestyle, or one that is slightly scaled back (to account for less space, transportation and spending needs)? That figure is your replacement rate. In other words, how much retirement income will you need to replace the lifestyle and income you’re used to throughout employment? While the Department of Labor recommends an 80% replacement rate, others hover around 70% in order to maintain a similar lifestyle pre- and post-retirement. As of 2013, Social Security will generally provide around 40% of your replacement income for current retirees. But, how will you account for the rest?
What’s happening around you?
Savvy planners know that retirement is in their own hands and not anyone else’s. While you will likely draw some form of Social Security benefits, the amount of these funds available will almost certainly change over time. Currently, Social Security benefits are calculated using an average of your earnings (after a minimum point threshold is met). As the number of Baby Boomers continues to place a strain on this program, it becomes more likely that the payouts will change. Similarly, if your employment contract includes a defined benefit pension plan, be aware that those payments are never fully guaranteed. Whether your retirement horizon is 5 years or 30 years away, stay informed about workplace retirement plan policies and Social Security regulation changes. This information is important to review as you shape the composition of your retirement income and your saving strategy.
So, when is the best time to start?
Older Americans who approach retirement without sufficient savings can make up for lost time by taking advantage of ‘catch-up’ contributions over and above certain ordinary thresholds. Younger Americans have time on their side. No matter your age, saving for retirement is about bridging the replacement income gap. What have you saved, and what do you still need to provide for the retirement of your dreams?
Measuring the gap lays the foundation for your retirement saving strategy.
Be sure to consult with a financial professional who can discuss retirement planning in more detail.
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