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Assessing the Impact of Missed Retirement Plan Contributions

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

With the unemployment rate stubbornly high and the economy still relatively weak, many employees have stopped contributing to their retirement plans.

Here to discuss some recent research into this topic is Christine Fahlund. She is senior financial planner with T. Rowe Price.

Chris, thanks so much for joining me.

Christine Fahlund: Delighted.

Benz: So, Chris, you came out with some very interesting and practical research into this topic of retirement plan contributions and why employees might stop them, but I would like to talk about the implications of this research.

If you are someone who has had to stop contributing to your retirement plan either because you have been laid off or maybe voluntarily decided to stay home and take care of your kids, what are the takeaways from the research that you recently did into this topic?

Fahlund: Well, if you are a younger saver, what we found was that missed contributions are going to have an impact by the time you reach a retirement date, but you have so many years in which to catch up, because you missed those contributions that in order to catch up, it's quite easy. You simply have to increase your contributions by a few percentage points, and you will be back on track. So that's the good news.

Benz: Right. But if you don't increase your contribution rate at a later date, you found that people who do stop retirement plan contributions early on in their careers, actually, it's pretty impactful in terms of their bottom line when it comes time for them to retire?

Fahlund: It certainly can be. For example, a 25-year-old who missed the first five years wouldn't be able to supply 50% of their retirement income from their nest egg at that point--it would probably be closer to 40% is the best they could do.

Benz: You used that 50% as kind of a baseline replacement rate?

Fahlund: Exactly. It can make a difference as to how much social security you are getting, but just in general that's a good rule of thumb. 50% should come from your nest egg.

Benz: One thing you found was that for older savers, those who stopped retirement plan contributions, that's harder to make up?

Fahlund: Well, that's the bad news. It's harder to make up, because you don't have time on your side. So, if you have to make up those contributions, they don't have time to grow for very long. So, the good news for the older investors is that they have already saved a nest egg and those additional contributions that they missed, probably wouldn't have had a large impact anyway.

So, they can relax a little easier knowing that they are going to have to look at other strategies. Just increasing their contributions isn't going to do it.

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Benz: And one thing that the data have shown is that people who are unemployed later in life are having a harder time replacing their job, so it might be realistic that folks could be stopping retirement plan contributions for a period of one or two years or more.

Fahlund: Yes, I think that we are looking for reassurance. Anyway we can run the numbers and come up with strategies that will help people stop worrying so much, that's one of our main goals at T. Rowe Price.

Benz: Okay. So, a more sobering set of news, though, Chris, from your research is that for people who have significant interruptions in their retirement plan contributions--more than a year or two--that starts to become more impactful. Let's discuss what you found there.

Fahlund: Yes. If you are going to be taking off five years, say from 25 to 30 and then you are going to take off another five years from 35 to 40, and then again at 45 to 50, we are looking at 15 years then and that can have a very strong impact. You simply aren't saving enough. So, there it would be hard to provide enough of a nest egg to support 50% of your income in retirement. There you'd probably be counting on a pension, for example, certainly Social Security and probably a part-time job.

Benz: Okay. So what's your general guidance to people on this topic, those who have lost jobs and stopped contributing and those who are still employed. What would you say to them?

Fahlund: Well, I would say that the most important thing is that you get back on track quickly. So, it's perfectly understandable that you may have some years when you are younger, when you can't contribute, but just as soon as it's possible, you need to get back up on the horse and get going.

Even if you can't contribute, our rule of thumb is you want to be contributing about 15% of your salary every year to your retirement, and that can include your employer match. But if you can't do 15, do 10, do 11 the next year, do 12 the next year, for example.

So it's very important that you continue making contributions, and if possible, they should be at least 15% of your salary.

Benz: And I know that you and many others in the field are also big fans of increasing when you get a raise?

Fahlund: Absolutely. There are lots of ways to do this and getting a raise and taking part of that raise and using that as additional contributions the following year can be an excellent way to go, where you really don't feel it. We like ways where you automate it, and you are not really feeling it. You've just programmed it into your future lifestyle. That's just a given that you are going to have the savings come out first.

Benz: Right, right. Well, Chris, thanks so much sharing this research. I think it's really interesting and useful research, particularly at this point in time.

Fahlund: Well, thanks so much for having me.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.