Did your clients (plan participants) recently receive raises? If yes, did you also recommend they increase the amount they’re saving for retirement?
The reality is that many American households are behind when it comes to saving for retirement, and receiving a raise can actually make it harder to achieve a comfortable retirement.
Why?
A new research paper from Morningstar’s behavioral science team tilted, “More Money More Problems,” finds that people generally don’t increase their savings rates when they get a raise. And “lifestyle creep”—where people tend to raise their standard of living as income increases, thereby raising their retirement needs—paired with the relatively fixed nature of retirement assets, means people may not be saving enough.
So, how can investors accommodate “lifestyle creep” and stay on track for retirement?
Morningstar offers a simple rule of thumb to help people stay on track: spend twice your years to retirement.
It means taking double the number of years left to retirement and using that percentage of your raise for discretionary purposes, while saving the rest.
And it’s important, according to Morningstar.
Income rises, savings static
“People tend to raise their standard of living as their income increases—we get used to the incremental lifestyle changes fueled by gradually increasing income,” the researchers note. “Yesterday’s indulgences become today’s new normal and tomorrow’s expectations, and studies show that personal happiness adjusts quickly to new spending levels, so the emotional benefit of a raise is fleeting.”
In other words, we might be momentarily happier with a larger house or fancier car, “but we adjust in a matter of months and are often left with higher bills and higher expectations for what we can afford.”
Even more concerning, they note “when people get a raise, their existing retirement assets—like Social Security retirement benefits and existing savings—stay static or grow more slowly than changes in income, and they may actually shrink in proportion to new retirement needs.”
To combat this, the authors offer up two additional solutions:
- Save your age, as a percentage of the raise: If clients are 50 years old, they should save 50% of the raise.
- Save at least 33% of the raise: If their take-home income increased by $1,000, they should save $333 of that new income.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
