Retirement savings: Benefits of boosting contributions
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We run the risk of stating the obvious: Increasing a person’s savings rate is one of the best ways to improve a household’s retirement prospects. Doing so increases the size of the financial war chest one can deploy in old age.
But according to financial advisors, there is a hidden benefit to taking a larger share of income; This also pushes households to live with less money, thus reducing the amount of money they will eventually need to fund their lifestyles in retirement. It may even help reduce the age at which someone can financially retire.
“A higher savings rate not only builds a portfolio faster, it also reduces the amount you need to retire,” Fran Walsh, co-founder of Opulus, a financial advisory firm based in Doylestown, Pennsylvania, recently wrote. to mail.
“Because if you live with less, you need less to sustain that life indefinitely,” he wrote.
‘It’s a lot more work than most people think’
Walsh gave an example to explain the concept.
Consider two households: They each earn $250,000, start saving at age 35, and earn a default annual return of 8%.
Household A saves 10%, or $25,000 per year. Household B saves 30% or $75,000 per year.
Then we use the so-called rule of 25 Determine households’ relevant savings targets. This framework uses household spending to approximate the size of an adequate nest egg by multiplying annual spending by 25.
Household A, who saves less and spends $225,000 a year, would need approximately $5.6 million in retirement savings to continue funding the lifestyle based on the rule of 25.
Household B, which saves more and spends $175,000 a year, would need about $4.4 million.
The result, Walsh wrote, is a reduction in the “finish line,” or retirement age.
According to his estimates, the first household could retire at age 73, while the second household could retire at age 57.
According to Walsh, the calculation does not take into account factors such as Social Security, retirement income, taxes, inflation or investment fees, all of which would affect the actual outcome.
“But the guiding point remains: the savings rate does a lot more work than most people realize,” he wrote.
What is a good savings rate?
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The question of how much to save is a constant headache for many households.
A household’s savings rate is often subjective; It is driven by factors such as desired retirement age and other financial goals, as well as unknown details such as: How long will a person live?
But there are general rules that can serve as a general starting point.
For example, some financial planners recommend what’s called the “50-30-20 rule” for developing a budget for spending and saving.
The numbers represent the share of your take-home pay allocated to different areas of your life: Half of your paycheck for necessities like food and shelter; 30% on discretionary spending such as entertainment and travel; and 20% for savings and debt repayment.
Walsh recommends saving at least 20% of income.
“If you can do this for 10, 20, 30 years, you’ll be in really good shape,” he told CNBC in an interview.
Often, households may start by saving enough for retirement, but may inadvertently fall behind due to “lifestyle deterioration” over the years.
In other words, people are getting raises and increasing their spending on things like bigger homes and fancier cars, but they’re not adjusting their savings upward either, the consultants said.
For example, a retirement saver who earns $100,000 per year and invests $20,000 per year will save 20% of their income. If their salary increases to $110,000 and $20,000 remains unchanged, that savings rate drops to about 18%; On a salary of $150,000, the rate is 13%.
How can I cut expenses?
It’s much easier for a young saver to form this habit early on, so they don’t become overly accustomed to spending trends that become difficult to unravel decades later, advisors said.
Uziel Gomez, a certified financial planner and founder of Los Angeles-based Primeros Financial, said people looking to cut expenses should do so gradually rather than making drastic changes that may be unsustainable.
“It has to be something very realistic that you can do,” Gomez said, a member of CNBC. Council of Financial Advisors.
“It’s like a diet: You want to do it gradually, not all at once,” he said. “When you lose weight, you do it slowly and surely, so your body adapts to the new way of eating.”
He said starting small and gradually cutting back helps people stick to the new plan over time.
For example, Gomez said he has customers who spend $500 a month on Amazon purchases. He said that instead of suddenly reducing this expense to $100 a month, he could first reduce it to $400.
Eating out (including takeout) and shopping are two categories where Gomez said he generally sees leeway for people to reduce spending.
“There is no universal right answer to what the savings rate should be,” Walsh wrote. “What’s important is that it’s intentional; it’s predetermined, not what’s left over after everything else.”
