René Nourse, CFP®
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 at age 40, a good rule of thumb is having 3 times your current annual salary already banked. If you are 50, you should have at least 4 times, and 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? There are a few ways to get there. And according to one study, just a few percentage points can make a dramatic difference over time.
Upsize Your Retirement Contributions
A study by the Putnam Institute contends that several variables—such as fund selection, asset allocation, portfolio rebalancing, and deferral rates—contribute to the effectiveness of a defined contribution plan (a.k.a. your 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 an individual’s contribution to their retirement plan was the most significant factor in boosting their retirement saving success.
As part of the 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 had jumped from $138,000 to $181,000, $272,000, and $334,000, respectively. Even with just a 1% increase—from a 3% to a 4% deferral rate—the individual’s final accumulation balance would be 30% greater than keeping it the same and relying on a fund selection strategy to try to maximize gains.
That 1% boost in income deferral would have had a wealth accumulation effect that was nearly 100% greater than selecting a growth investment strategy and 2,000% greater than just rebalancing the 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 usual annual maximum into your 401(k), 403(b), or TSP account. The maximum amounts you can contribute to your tax-deferred retirement accounts, as well as the allowed “catch-up” amount, change every year with the tax code. However, utilizing the catch-up provision can allows you to put away thousands more each year—adding to your retirement, and reducing your tax burden at the same time.
If you can’t take advantage of this strategy right away, slowly begin increasing your contributions until you meet the maximums. It’s also a good strategy to increase your contributions as soon as you receive a pay-raise or a bonus. You won’t miss the money, because you weren’t getting it before!
The catch-up provision does require a separate enrollment election, so be sure to sign up for it through your employer. If you continue working past age 65—as many people are choosing to do—you can continue to fund your employer retirement plan until you do stop working, giving you even more 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. Review your contributions at least annually and/or when there has been a financial or life-changing event. It will help you to stay on top of your financial planning process.