Small Changes Each Year Can Net Huge Results in Retirement
Retirement is one of the most talked about subjects in the personal finance realm, and for good reason. Although nearly every American has the dream of retirement as one of their financial goals, most people face significant challenges to their goal of a comfortable retirement.
Understanding the truth behind the challenges is the first step to overcoming them. Then, take control of your retirement through the only vehicle you actually can control: your personal savings and investments for retirement.
Challenges to Retirement
The traditional three legged stool of retirement (Social Security, Pensions, and Personal Savings) won't be the basis for a comfortable retirement in the future. Each leg of the stool has deteriorated over the years. As a result, without significant advanced planning and preparation, the likelihood you will have enough money in retirement is about the same as Justin Bieber maturing into a fine young man. That is to say, the chance is very low.
First Leg: Social Security
Social security provides a base-level safety net, but few would consider a social security check to be a comfortable retirement. According to the Social Security Administration, in 2017 the average monthly Social Security benefit check for retirees is $1,360. With an annual benefit of just $16,320; social security provides an average annual income just above the Federal Poverty Line of $12,060 for individuals.
Compounding the meager safety net is the fact that social security has been and continues to be in danger of running out of funds for future recipients. The huge population of baby boomers is blamed for this problem, as they are now entering retirement in droves. Similarly problematic, however, is the fact the baby boomers didn’t have as many kids, meaning fewer workers are in the workforce to support current and future retirees.
According to Social Security data, there are only 2.8 workers supporting each retiree in 2013. This compares to a ratio of 16.5 workers per retiree in 1950. Granted, the worker to retiree ratio dropped dramatically in the early decades of Social Security, but the 2.8 ratio is significantly lower than the ratio of 3.3 which persisted from 1975 to 2008. As fewer workers enter the workforce even while more workers reach retirement age, the social security system will experience significant additional stress.
Second Leg: Pensions
Pensions, both public and private, aren’t fairing much better than Social Security. Private pensions have all but disappeared as companies shift from the unknown risk of future pension obligations to offering the predictable current expenses of 401(k)s.
Public pensions don't seem to be disappearing, but the pension benefits they offer are diminishing. Those who are part of the public pension system within their state should be aware of the financial difficulties and funding shortfalls the systems are experiencing.
According to Stanford’s PensionTracker.com, every state has unfunded pension obligations which would fall either on the state tax payers or the pensioners to pay for either through additional taxes or reduced pension benefits. The study shows state ‘pension debt’ ranging from $14,020 to $110,528 per household in each state.
If you currently are part of a pension plan, you should consider alternatives for providing for your retirement. Public and private pensions both face a possible inability to cover pension obligations. And many have sought court approval to lower pension benefits for current and future retirees.
Third Leg: Personal Saving
That leaves one leg of the stool left, personal savings. These include your 401(k)s, IRAs, 403(b)s, income producing assets, and other savings instruments. Even with all these options, the average retirement savings for Americans is significantly less than is necessary to provide for a comfortable retirement.
Averages, of course, can be misleading, as they include both those nearing retirement and the young with 40 years of savings still ahead of them. If we look only at those on the verge of retirement, who should have the most saved, the numbers still don’t look all that rosy.
A June 2015 Government Accountability Office study found those 55 to 64 had an average of $104,000 saved for retirement. That nest egg would result in a $347 monthly income based upon the 4% safe withdrawal rate, and even less if you were to use the money to purchase an annuity.
And although personal savings too is wobbly, this is the leg which can save your retirement as you have complete control over it.
The Opportunity for Earlier and Wealthier Retirement
The fact you are solely responsible for your retirement may seem daunting, but there is significant hope in it as well. Because it is up to you to fund your retirement, it also means you are in control of when you retire and how much money you will have to spend in retirement.
The more you save toward your retirement, the more options you have. A general rule of thumb is to save 10%-15% of your income each year toward your retirement. Most experts agree at this savings level, you will be able to replace your full income in retirement. And saving more will provide you with options for either an earlier or a richer retirement.
Whether you are just beginning a retirement investing plan or are mid-way through, the competing goals and responsibilities in your life can make it difficult to put the suggested 15% of your pay away each month toward your retirement. Fortunately, using one (or more) of the following strategies can help you achieve the 15% number without feeling pain.
Instead of attempting to jump straight to a 15% savings rate, start with something small and manageable. If all you can afford in your budget is 3% of your income to get your employer’s match, then begin there. Each subsequent year, however, move the percentage up at least 1%.
If you make $60,000 a year, at 3% you’re putting $150 a month toward your retirement. Going from that to $750 each month will likely not fit in your budget. But it will likely be easy to go from $150 a month to $200 per month (3% to 4%). Over a decade, you’ll achieve the 15% of your income number when the employer match is included.
Split Raise Method
Again, starting with the same 3% of your income, you can quickly grow your retirement savings percentage without feeling any pain to your budget by splitting any raises you get between yourself now and yourself in retirement. As your income goes up, take half of the increase and spend it, and take the other half of the increase and put it toward retirement.
Say you got a 5% raise, increasing your salary from $60k to $63k. Taking $1,500 of the raise and diverting it to your retirement account will still leave you with $1,500 to spend on new luxuries and fun. Your lifestyle will improve, but you’ll also have moved your retirement savings rate from 3% to over 5%! Adding in the 3% employer match and you’ll be closing in on the 10% figure.
Debt Diversion Method
If you are currently working through paying down consumer debt, such as credit cards and high-interest auto loans, then focusing on debt may be a better alternative. Just make sure to at least get the employer match if you have one.
As you eliminate debt, however, you can begin shifting the money from paying off debt to investing for retirement. Even if you only put half of the money toward retirement, you’ll end up with a significant increase in your retirement savings with no impact on your current lifestyle.
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Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at firstname.lastname@example.org