Christine Benz: Hi, I'm Christine Benz for Morningstar.com.
Many Americans find themselves playing catch-up when it comes to saving for their own retirements.
Here to share some tips for doing that is Christine Fahlund, she is a senior financial planner with T. Rowe Price.
Christine, thank you so much for coming in.
Christine Fahlund: My pleasure.
Benz: You recently produced some research where you looked at what levers people can pull when they find themselves in this situation. They've run the numbers on what it will take for them to retire, the income they need, and they see that they will fall short if they stay on path with their current savings plan.
So, let's talk about the levers that people can pull when they find themselves in this situation. I think some people might be naturally inclined to just make their asset allocation really aggressive and hope that that will pick up the slack for them, but you think that there are some better ways to go about it.
Fahlund: Absolutely. Ironically, we do tend to think of the asset allocation first, and that can be, more generalized, somewhere between 40% and 60% in equities as you approach retirement, so that's really not the key.
The key is saving. So, if you're afraid that you're not going to achieve the goal that you want, then the first thing you should do is try to increase the amount you're saving, the percent of salary.
So a lot of people today are contributing around 10%. They really ought to be contributing 15%, and if they're behind, then definitely see if you can inch your way up to 20%, so that will make a big difference long term.
Benz: So savings rate, and you have also done some work on pushing retirement dates out further into the future--just how impactful that can be. So you pick up dollars on a couple of different fronts: You are deferring your Social Security receipt date, you are continuing to contribute to those retirement plans, and probably most importantly you are not dipping into your nest egg.
Fahlund: Those are all key points. Putting time on your side is the most important concept for folks who are in their 50s, for example, to realize and understand. Some who have just had their children go through college say, "Now it's our turn," and so they start to take those trips, perhaps a little prematurely.
What makes more sense is to accelerate the savings while you are still in your 50s. That puts some more time on your side for those contributions to compound. If you wait until your 60s, now the contributions will mean less. They will have less of an effect because they have fewer years to compound. So if it's going to be a trade-off, and you try to catch up in your 50s or 60s, front-load it in your 50s.
Benz: So tighten your belt sooner.
Fahlund: That's going to make such a difference, because it's going to take the pressure off when you hit your 60s, and you are still in great shape to go have those trips.
Benz: One thing that you looked at in the scenarios that you modeled out, Chris, was the effect of cutting costs, even around the margins, [which] can be quite impactful in terms of getting you closer to hitting your desired in-retirement income. What are some examples of cost savings that people can take when they are in the 50s or in those pre-retirement years?
Fahlund: Well, some of my younger colleagues immediately suggest you get rid of your landline phone.
Benz: Okay, I have done that. So, check.
Fahlund: Very good. All right. Another would be flexible spending accounts. If you have one at work, it's a good idea to take advantage of that. You can save some on taxes when you're paying child-care expenses, medical expenses, for example. There may be other things, like maybe you don't go to Whole Foods quite as often instead of...
Benz: Mix it up, or only for special occasions...
Fahlund: Mix it up a little bit, right. It's little things, and they won't add up to a tremendous improvement, but they will definitely help.
Benz: So you also talked about making sure that you are earning matching contributions, those can help kick up your retirement savings and get you closer toward that in-retirement income goal as well.
Fahlund: Leaving [employer] matches on the table is unconscionable. Absolutely, that's free money. So if your employer is offering you a [retirement plan] match, you always should contribute up to that point, so that you get the full match.
One thing that's kind of interesting--you were mentioning working longer, perhaps, to put more time on your side for your nest egg to compound. As you are working longer, I start to think of that as a match. If I work one extra year, and I was making $75,000, one extra year is $75,000 that I hadn't saved that I can spend, so that's almost a 100% match, if you think about it in the same terms.
So we must not look a gift horse in the mouth. If you have a good job and you're not at risk, even if you are not enjoying it quite as much, think about sticking with it, because the benefits for you will be tremendous long term.
Benz: So in this research, you used a 75% income replacement rate. So you assume that the person, when they retired, would be needing 75% of what they earned while they were working. How do you arrive at that? I know retirees really wrestle with how [to arrive at] that number? I know 80% has been floating around there. How should people think about setting what will be their real spending rate in retirement?
Fahlund: Well, we have an assumptions committee at T. Rowe Price that's across the firm, where we have people from all different areas of finance, and we sit down once a year and we talk about what that replacement income needs to be. And if you go back to our rule of thumb that we think you ought to be saving at least 15% of your salary every year, well, then that's money you're not [receiving] now.
Another expense that we all have are FICA taxes. Now they've been reduced for a couple of years, but generally speaking, if you combine the FICA taxes that you always pay, plus your [retirement plan] contributions that you always make, that's about 25% of your pre-tax income that you're not receiving, that you aren't able to spend while you're working, so 75% makes sense to be replacing in retirement.
Benz: Right, and it's not as though you necessarily need to be planning on a decreased standard of living; you are not having to do the senior specials and all that stuff. Right there, with those two items, that gets you to 75%. You think that's a reasonable threshold?
Fahlund: It is, and I would say 80% is also reasonable. 100% for some people is almost mandatory. It makes a difference on what your lifestyle is. So these are rules of thumb, but if you have an extravagant lifestyle, you certainly want to head for the high end of that.
Benz: Right. Well, Chris, thank you so much. This is always very helpful research, and it's always great to hear from you.
Fahlund: It's a pleasure.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.