If you’re like most employees, one of the most important decisions that will impact your financial future has already been made for you.
In 2006, Congress passed the Pension Protection Act. Despite the law’s name, it represented a watershed event for retirement savers using a 401(k) plan. It allowed employers to change how employees enroll in their retirement plan.
In the past, you had to opt-in. Now, for the most part, companies will automatically enroll employees into the 401(k) plan. The employee still has the opportunity to opt-out, but most don’t.
As a bonus, not only are you automatically enrolled, but you don’t even have to decide where to invest. The plan will do that for you.
Here’s the thing, though. That automatic savings rate is usually much lower than what you need. It may not even be enough to take full advantage of the company match.
So, what is the appropriate amount to save? What percentage of your salary should you defer into your retirement plan?
There’s a pretty strong consensus among retirement advisors regarding that number (albeit with slight variations).
“Broadly speaking, targeting a salary deferral percentage of at least 15% of gross income will allow a saver to be better positioned to meet their retirement goals once Social Security and working to a normal retirement age (like 65) is factored in,” says Rob Comfort, President of CUNA Brokerage Services Inc. in Madison, Wisconsin. “The ideal percentage, however, will vary depending on many different factors.”
Of course, while the range may be the same, the nuance of that range may be different. For example, some feel younger employees can afford to save less, while others believe they should seize the asset of time and save more. For example, Katrina Soelter, Director, Wealth Management at KCS Wealth Advisory, LLC in Los Angeles, says, “usually employees should save between 15%-20% when starting to save in their late 20s/early 30s.”
On the other hand, Comfort says, “A younger worker could start out saving 10 percent, with regular increases after that, whereas a saver who starts later will likely need to start at a higher percentage since they don’t have as much time for their accounts to grow.”
Assessing your situation begins with a simple universal step. It’s the one you’ve heard many times.
“First, contribute enough to receive your employer’s full match,” says Ryan McPherson, Director of Financial Coaching at SmartPath in Atlanta. “That’s free money! Beyond that, most people should save about 20% of their total salaries each year for retirement. That 20% includes your employer’s match; so, if your employer puts in 5%, you’d need to contribute 15%.”
Despite this apparent agreement, there’s more to determining your salary deferral rate than a common template. You might start with that common template, but it gets increasingly aggressive very quickly after that.
“One size does not fit all,” says Matthew Fox, Founder & Wealth Advisor at Ithaca Wealth Management in Ithaca, New York. “At the bare minimum, employees should defer enough to take advantage of any and all company match benefits. From there, the ideal target would be a percentage that reaches the max annual 401(k) contribution limit of $19,500. Obviously, this is a high bar to reach: an employee who earns $75,000 annually would need to contribute nearly a quarter of their salary each year.”
As ambitious as it sounds, saving the maximum does represent a goal. It’s not an easy goal, as Fox implies, but it gives you something you can really sink your teeth into, especially once you see the potential pot of gold at the end of the rainbow that comes with saving the max.
“Most people ought to contribute the maximum,” says Roger C. Hewins III, President of Team Hewins, LLC in Redwood City, California. “The power of compounding is amazing. You need to put it to work for you starting as early as possible. People typically don’t think hard enough about how much they will need to retire and how long it will take to save and invest enough to have financial security. If you cannot do so now, try at least to contribute the amount to get the full employer match. It is free money. Then work your way to the maximum depending on cash flow needs.”
No matter how you slice it, it starts with a minimum savings rate that’s high enough to capture the full company match, and ends with a savings rate that allows you to contribute the maximum allowable by law.
“A broad rule of thumb is that someone should do at least what is matched – otherwise they are leaving ‘free money’ on the table,” says Randy Carver, President and CEO of Carver Financial Services in Mentor, Ohio. “Most experts recommend deferring at least 10%-12% of salary. For 2020 this is limited to $19,500 for 2020 (up from $19,000 in 2019); that limit increases to $26,000 (up from $25,000 last year) if you’re 50 or older. Employer contributions are on top of that limit. These limits are set by the IRS and subject to adjustment each year.”
Unfortunately, most people stop at either the automatic enrollment deferral or saving enough to earn the entire company match. Beyond that, though, your actual number is a very personal number. You won’t find it in a book. You can only discover it by closely scanning your specific situation.
“A percentage isn’t the easiest answer,” says Paul Miller, Founder of Miller and Company, LLP in New York City. “As this is very individualized, each person must look at their budget and what they can afford to put away. After you look at your budget you need to look at the after-tax benefits, which most likely will allow you to contribute more.”
What are some of the data points you’ll want to explore when deciding how much to defer?
“There is no specific deferral percentage that an employee should target,” says Jason Field, Financial Advisor at Van Leeuwen & Company located in Princeton, New Jersey. “It is all dependent on financial situation, salary, employer matching, and many other factors. An employee should, at minimum, contribute to get the full match. Depending on the goals of the person, even maxing out their 401(k) may not be enough to reach their future goals. Many people may need to look beyond their employer plan to save enough for retirement.”
Don’t forget, this isn’t just a plug-and-play one-time calculation. You’re going to need to keep tabs on how you’re progressing towards your goal and make any mid-course corrections as necessary. As a result, the method to find your optimal salary deferral rate is an iterative process.
“It depends on your age and how ‘on track’ you are for retirement,” says Laura Kirkover, Head of Retirement Plans and Retirement & Investment Product Consulting at Wells Fargo Advisors
As a practical matter, particularly if you’re young and have other obligations, you may be a bit tentative when it comes to committing a large sum toward retirement savings. That doesn’t mean you can’t adopt a reasonable strategy to get to your desired savings rate.
“For most Americans, contributing a quarter of their salary to a 401(k) is unrealistic,” says Fox. “Instead, aim for a bare minimum of 5%, and bump that up by 1% every few months until you notice a difference in your paycheck that you are uncomfortable with. If your employers’ 401(k) platform provides the option to turn on an automatic 1% contribution addition every year, turn it on. You will likely not notice the difference in your paycheck after it bumping up 1% each year. This tactic also helps prevent lifestyle creep.”
It is the very sense of “lifestyle creep” that makes a high savings rate so important. If you defer 20% of your salary into a retirement plan, you’ll only have 80% of your salary to spend (actually less if you consider taxes and other deductions like Social Security). This allows you to grow accustomed to living expenses that are more reflective of what you might find in retirement.
Becoming a retirement supersaver not only prepares you financially for retirement, it also gets you ready for experiencing retirement living expenses.
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