It doesn’t take an advanced degree in finance to know that the more money you put into your retirement account, the more you’ll have to spend later. But when it comes to contributing to that retirement fund, how much should you be putting away annually? And how much should you plan to have saved at different ages to make sure that you can live comfortably in retirement? For an individual, age 40, a good rule of thumb is having 3 times your current annual salary already banked. If you are age 50, you should have at least 4 times — ideally 5 times — your annual salary saved. So if you’re making $90,000 a year, you should have a minimum of $360,000 already saved.
What happens if you’re not there yet? Here are a few ways to get there. And according to a recent study, the difference a few percentage points can make over time is dramatic.
A study by the Putnam Institute “Defined Contribution Plans: Missing the Forest for the Trees?” contends that while a number of variables — such as fund selection, asset allocation, portfolio rebalancing, and deferral rates — all contribute to the effectiveness of a defined contribution plan (a.k.a. 401(k) or 403(b) plans), the one variable that had the biggest impact was the deferral rate. In other words, the rate and amount of contribution to an individual’s retirement plan was the most significant factor in boosting retirement saving success.
As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively. Even with a just a 1% increase from a 3% to a 4% deferral rate, an individual’s final accumulation balance would have been 30% greater than it would have been using a fund selection strategy. Furthermore, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% greater than selecting a growth investment strategy, and 2,000% greater than rebalancing your portfolio periodically. Of course, these results are hypothetical and past performance does not guarantee future results.
But here is something else you need to know: if at age 50 or so you find you’re a bit behind in your retirement planning, consider supersizing your contribution. You can take advantage of the “catch-up” provision, which allows you to put away more than the annual maximum into a 401(k)/403(b)/TSP. In 2017, the maximum contribution is $18,000 — BUT utilizing the catch-up provision allows you to put away up to an additional $6,000 more, for a total of $24,000. If you can’t take advantage of this strategy right away, slowly begin increasing your contributions until you meet that maximum. It’s also a great strategy to increase contributions after receiving a pay-raise or a bonus. You won’t miss it, because you weren’t getting it anyway! Just remember to sign up for the catch-up provision through your employer: it does require a separate enrollment election. If you continue working past age 65, which many people are choosing to do, you can continue to fund your employer retirement plan until you stop working, giving you extra time to put money away.
So the bottom line is this: increasing your deferral rate could be the best and easiest way to grow your retirement assets. By contributing more, you stand a better chance of achieving success in your overall retirement planning process. Retirement will likely be one of the biggest expenses in your life, so make it a priority to calculate your savings goal at least once a year. Reviewing these points at least annually and/or when there has been a financial or life changing event will help you to stay on top of your planning process.