Retirement Saving: What Comes Natural is Worst Approach

Most people delay saving for retirement until their income goes up and retirement age is on the horizon. It makes sense. But it doesn't work. Here's why.

  • Share
  • Read Later

A disturbing pattern surfaces when you quiz baby boomers about their savings habits. The remarkably common experience they relate is that they saved nothing in their 20s and very little in their 30s; they started saving regularly in their 40s but didn’t get serious until their 50s.

This progression is understandable. It generally tracks with rising income and urgency as people age. It’s also exactly opposite the most efficient way to build retirement security.

Morningstar analyst Christine Benz recently polled the firm’s individual investor clients and found that few stuck to any rules of thumb, like saving 10% of pre-tax income each paycheck. Most regretted that they had not started saving earlier. Commenting on a lengthy online thread that her poll generated, she observed:

“The savings pattern laid out by Keith999, who expects to embark on a financially secure retirement soon, will ring true for many investors. ‘In my 20s I spent, in my 30s I spent more, then in my 40s began saving about 6% of salary, early 50s about 12%, and the last 10 years I/we saved 20% of two salaries. The last 10 years probably represent over 50% of the total saved and indeed has put us over the top of what we need.’”

(MORE: Women and Money: Why You Need to Take Control Now)

Keith999 may have secured his retirement this way. If so, he did it the hard way by turning his back on what Einstein purportedly called the most powerful force in nature: compound interest. Consider two savers. One starts at age 20 and saves $2,000 a year for 10 years and then stops saving altogether. With 7% annual growth she’d have $315,676 by age 65.

The other saves nothing until age 40, and then socks away twice as much each year—$4,000—for more than twice as long, in this case the next 25 years. Even with this aggressive catch-up plan she would fall short of the first saver’s total, socking away just $270,705 by age 65. Now imagine the first saver did not stop saving, but kept plowing in $2,000 a year throughout her working life. She’d have $611,503 by age 65. If she upped the contribution to $4,000 at age 40 she’d have almost $750,000 at retirement.

Saving early is the almost painless trick to building retirement security. Young people should open a Roth IRA as soon as they have wage income. If parents have the means, the best gift they can give a working teen or young adult child is a contribution to their Roth in an amount equal to the child’s earned income up to the $5,000 annual limit. I call this a family 401(k).

(MORE: What Not to Buy in September)

We have a retirement savings crisis in the U.S. that is prompting millions of people to plan to work longer in order to make ends meet when they finally call it quits. The Employee Benefit Research Institute’s 2012 Retirement Confidence Survey found that 37% of workers expect to work past age 65, and most of those past 70. That compares to just 11% who expected to work past age 65 in 1991.

Working longer alleviates the problem for many, but generally not for those most at risk. In his blog for EBRI, Nevin Adams writes:

“Last year we modified the Retirement Security Projection Model to determine whether just ‘working a few more years after age 65’ would indeed be a feasible financial solution for those determined to be at risk.  Unfortunately, for those counting on that as a retirement savings solution, the answer is not always yes. Indeed, results from the EBRI modeling indicated that the lowest pre-retirement income quartile would need to defer retirement to age 84 before 90% of the households would have even a break-even chance of success.”

For most people, saving early is the only true silver bullet. Too bad we don’t seem to realize that until it’s too late. In the Morningstar poll, older clients said they were now trying to pass that wisdom along. Writes Benz:

“Many posters noted that they wish they had the importance of saving drilled into them earlier, so they are doing their best to inculcate their children in the merits of saving aggressively. Offthegrid wrote, ‘Not enough education or attention is given to the power of investing when you are young.’”

(MORE: The S&P Soars, the Economy Snores)

It’s time to change that by making financial education part of every child’s school experience. In the meantime, start a family 401(k) for your kids. Even a modest annual contribution can lead to big savings over 50 years. It also sets a good example.