The Challenge of Saving for Retirement

SmallBiz Small Talk (In this Friday, July 28, 2013 photo, Michael Maher, co-owner of Taylor Stitch, poses for a portrait at his
Marcio Jose Sanchez/APLike many younger workers, 28-year-old Michael Maher, co-owner of Taylor Stitch, a San Francisco clothing retailer, says saving for retirement isn't a priority.

By Ann G. Schnorrenberg

The current personal savings rate in the United States is not a number to inspire confidence. Yes, it has almost doubled in the past five years. However, the current rate remains only half what it was 50 years ago. Furthermore, not everyone is saving (baby boomers are more likely to have a retirement account than other generations).

What is happening here? Is there a generational shift in savings tendencies, or is it simply an example of myopic vision in which people don't think about saving for retirement when it seems so far in the future? There is some evidence of a generational shift. Members of older generations are more likely to have retirement accounts. They are also more likely to have a longer time horizon for their investments than younger individuals.

Despite this generational shift, younger generations actually need to save more than their parents. There are several problems that they face:

Pensions on the decline: There has been a significant change in retirement benefits since the establishment of 401(k) plans in 1975. Whereas companies used to fund employees' retirement through pension plans, most now have plans that require active contributions from employees. The irony is that this change of funding from employer to employee is concurrent with the declining savings rate.

Social Security: Since the Social Security Act was signed in 1935, life expectancy has risen and the number of workers per beneficiary has fallen. The full retirement age is already rising and there may be additional changes in order to keep the system solvent. Furthermore, Social Security was established as a safety net rather than as a total wage replacement vehicle. Although individuals with low earnings ($13,100 annual salary) will receive Social Security benefits equal to 89 percent of their wage, those at the top of the pay scale (over $200,000) will only receive a wage replacement rate of 20 percent from Social Security. For the average American, 40 percent of retirement income comes from Social Security.

The propensity to save is established young: A study by David Whitebread and Sue Bingham, "Habit Formation and Learning in Young Children," shows that children learn (or fail to learn) habits from their parents and teachers at a young age. Although they may not understand financial concepts such as delay of gratification, they may learn habits of mind such as impulse control, persistence, and thinking outside the box. These skills can be critical as adults for balancing current expenditures with saving for a future retirement.

Absence of savings: The average personal savings rate of 4.6 percent is just that -– an average. The disturbing statistic is the number of people with no savings. According to a Harris Poll taken in 2011, one-third of Americans have no retirement or personal savings.

So the question is, "How much money should I be saving?" Obviously, this will vary from person to person, depending upon their expected retirement age, income level and wage replacement rate. A general rule of thumb is that retirement savings should be 10 percent to 13 percent of income. However, this is for an individual who starts saving in his early 20s.

The longer a person waits to start, the harder the task becomes, not only because there are fewer years to save, but also because there are fewer years for the savings to grow. Thus, an individual who begins saving for retirement at age 35 to 45 must save 13 percent to 20 percent of their income and an individual who starts saving at age 45 to 55 must save 20 percent to 40 percent of their salary. Later savers are also more likely to have to delay retirement.

Changing one's finances to move from being a consumer to being a saver is not easy. Often, fixed spending commitments such as a mortgage are not easily (or cheaply) changed. Some suggestions for gradual change follow:

  • Increase savings as salary rises: It is easiest to save money you didn't have before. Put some of each pay raise into savings. If the percent of raise saved is greater than the percent of prior salary saved, then your savings rate will increase over time.

  • Keep a budget: Many individuals do not even know how much money they spend. Often, people simply spend money by habit. Although keeping a detailed budget may be useful if there is a need to adjust expenses, a first step may simply be to do a net income/expense calculation. That is, make sure expenses (checks, credit card expenses and debit charges) combined with taxes and savings are no more than total income. The object is to keep expenses below net income with the balance going to savings.

  • Maximize retirement benefits offered by your employer: If your employer offers a retirement savings match, be sure that match is your minimum deferral. Don't leave money on the table.

  • Monitor your net worth and debt: In order to meet your goals, your net worth should be rising and your debt should be falling. Ideally, your net worth should be 16 to 20 times your gross pay by the time you retire and debt should be paid off. Tracking your net worth over time will allow you to monitor your progress.

These suggestions merely provide a general guideline to retirement savings. For individuals who have begun their retirement savings, but want a more clear sense of whether they are on track to meet their goal, or individuals who need to coordinate multiple financial goals, more in depth analysis may be useful. This can be done through a capital needs analysis or a simulation analysis. Many financial websites have tools to assist in this planning, or a financial planner can help figure out how to coordinate and fund these goals.

Ann G. Schnorrenberg, Ph.D., is a Financial Planning Associate at Monument Wealth Management, a Registered Investment Advisory firm located just outside Washington, D.C. in Alexandria, Va. Follow Ann and the rest of Monument Wealth Management on Twitter, LinkedIn, YouTube, Facebook and their "Off the Wall" blog which can be found on their website.

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