Here’s something you already know: Some people save a lot more for retirement than others. But here’s something you may be very eager to learn if you’re among the retirement savings laggards: there are concrete steps you can take to catch up. And those are practical and easy steps for the typical person.
“The reason that you can improve is that you don’t have to become a super saver overnight,” said Joleen Workman, vice president, customer care for Principal Financial Group.
The gap between some groups’ average retirement savings is dramatic. One quarter of U.S. adults have retirement savings of $200,000 or more, according to Northwestern Mutual. Not bad. Yet 50% have less than $75,000 in retirement savings.
A lot of those laggards are younger workers who have not had time to build up big balances. Still, many of those laggards are old enough to have accumulated more retirement savings. But they aren’t trying hard enough or aren’t using effective steps to build their accounts.
Among millennials and Gen Xers in 2016, only 2.4% socked away at least $16,200, which was 90% of that year’s 401(k) contribution cap of $18,000, according to Principal.
What’s the alternative to saving enough when you’re young? If you don’t make sure your retirement savings are growing fast enough while you’re still working, it can impact your lifestyle in retirement.
IBD’S TAKE: Once you are saving enough, make sure your retirement savings earn a top-notch rate of return by sharpening your mutual fund selection skills.
Retirement Savings: How To Step It Up
Workman suggests four steps that are especially helpful for younger workers who want to boost their retirement savings.
- Start early. “My No. 1 advice is to start saving as early as you can,” Workman said. “The power of compound earnings is significant. The more time your savings have to grow, the more they can grow.”
Here’s a simple illustration. Suppose you save $100 per month in an IRA, where your portfolio earns 6.5% a year for 10 years. After a decade, your account will be worth just shy of $17,000, according to the compound interest calculator at the calculatorsite.com.
Now see what happens if you start five years earlier. After a total of 15 years, your balance would be $30,519. The five year head start — giving you 50% additional time — results in not just a 50% gain in money but in an 80% gain.
And after a total of 20 years, your retirement savings balance would be $49,308. So 100% extra time leads to a 191% gain in your balance.
That’s the power of compounding.
- Build up. Even if you start saving small amounts, increase your savings by modest amounts.
Workman recommends increasing your savings rate by 1% a year until you are saving 10% to 15% of your income. “We suggest people contribute 10% every year plus whatever your employer matches” in a 401(k) plan, she said.
Suppose you’re earning $70,000 a year at work and you save 3% of that. Let’s say your employer diverts your savings once a month into a 401(k) account, and that you earn 6.5% a year, compounded monthly. Your balance after one year would be $2,175.
Look what happens if you increase your rate of savings by 1 percentage point a year. In the second year, your savings for those 12 months would total $2,896. In the third year, your total savings for the year would amount to $3,630.
By the eighth year, your savings rate would be 10%. Savings for that year would come to $7,247. As each year’s total continues to compound, your grand total would reach $45,136.
Without the 1 percentage point boost in savings rate each year, your total with ongoing compounding would be $22,077.
Boosting your contribution rate by 1 percentage point a year becomes easier if you apply any bonuses and pay raises toward that. And that should be very doable for many workers. Mid- to large-size companies expect to dish out pay raises next year averaging 3.1% to nonmanagement white collar workers, up from 3% this year.
- Make a budget. If you want to understand how much you can afford to kick in to your retirement accounts, crunch the numbers.
“Look at your income,” Workman said. “Look at your expenses. Look at your debt.” After you pay for monthly essentials like food, housing and insurance, how much is left over?
You can look at different outcomes by shifting some expenditures from the discretionary spending category to the must-have category — or vice versa.
Retirement Savings: Turning A Negative Into A Positive
- Cut spending. One of the most effective ways to do that is by paying off credit cards that charge you a high interest rate.
Credit card rates average nearly 14% now, according to valuepenguin.com. The most costly cash back cards charge nearly 23%. If you get rid of a credit card that’s charging you 23% a year, that’s like having an investment that pay you 23% instead.
What are the ways you can cut spending? The four most common tactics cited by millennials and Gen Xers are putting up with work-related stress for the sake of a better paycheck, traveling less, driving an older car and owning a modest home, according to a survey by Principal.
Additional tactics: settling for bare-bones furnishings and renting a residence instead of buying a home.
“You can still go on vacations and pay for entertainment,” Workman said. Just take vacations less often, to less expensive destinations. Ditto for other discretionary spending.
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