Most financial planners say you need to set aside at least 10% to 15% of your pay to fund a long, comfortable retirement. In fact, a 15% savings rate is what a 40-year-old who earns $90,000 a year, starting from scratch, would need to get to $1 million by retirement. The prospect of cutting your spending by double digits probably doesn’t sit well. Behavioral finance research tells us that “a small number of people might be able to stomach a big spending cut,” says Shlomo Benartzi, a UCLA professor and the chief behavioral economist at AllianzGI. “But for most it’s a bit too difficult.” Saving 15% of your pay, however, may not require a drastic change in lifestyle, especially if you follow these steps.
What to Do
Use all your 401(k) tools. When you “save” 15%, remember that six percentage points typically come from employer matches. Take full advantage and your company will kick in a big chunk of your nest egg (see chart). But don’t forget other savings enablers.
For instance, if you started at your firm a decade ago, your plan probably didn’t offer auto-escalation, a tool allowing you to gradually raise your savings rate. Today 53% of employers do. Use it. In one of Benartzi’s experiments, employees at a midsize manufacturing firm said they couldn’t afford to save as much as they needed. They were persuaded, though, to raise their rate gradually, by three points a year, tied to expected raises. At the end of the study, workers boosted their average savings rate from 3.5% to 13.6%, far more than they thought possible.
Get ready to harvest raises. You probably haven’t seen much wage growth since the financial crisis, when 75% of companies froze salaries. Things are looking up: 96% of employers plan to give raises in 2014, and employees can expect a 3% hike on average, according to Towers Watson Data Services.
Boost your 401(k) contribution rate by nearly that amount before the raises kick in, says Donald Albacker, a financial adviser from Newtown, Pa. Here’s why: If you earn $100,000 and save 10%, you’re living on $90,000. Raise that rate two points a year for the next two years, and your savings rate will hit 14%. Yet you’ll still live on around $90,000. You will have to cut spending a bit, owing to inflation. But the pain will be nothing like going from 10% to 14% savings on your old pay.