Optimal Salary Deferral Rate to Meet Your Retirement Goal: It’s Not a Percentage
Many people just aren’t saving enough for retirement, as key statistics indicate. In the 2019 Retirement Pulse Survey by TD Ameritrade, it illustrated that 88 percent of retirees have less than 1 million dollars saved to live off of. The purpose of this article is to share the idea of an optimal salary deferral strategy. Hopefully, this can help employers and employees better prepare their benefit strategy to help address this growing concern.
When it comes to planning your retirement income, your savings strategy is crucial to meet this long term goal. Given that your savings will have to account for a majority of your income, the sooner you start to get control of your retirement savings habits, the better you will be prepared for it. Traditionally, most people are accustomed to saving a percentage of their income into their employer retirement account. Many opt-in up to the level of the employer matching level. Depending on the employer retirement plan, matching contributions can range from 1% to as high as 9%. This means that many employees are simply saving up to the matching amount, and, as a result they will fall short of achieving enough to maintain their accustomed level of living in retirement.
Depending on what stage of saving you are in, in terms of just starting your career, in the middle of it or towards the tail end of it, how you save should depend on one single factor. That factor should be how much total you want to save. This obviously could change if you are younger or middle-aged and as your income rises. This notion of a percentage is useful, but it falls short of the reality of what you really want to accomplish. What you want to accomplish is a defined dollar amount that you take aim on to help you achieve your financial goal of living how you want to live in retirement.
For example, if your household income is $100,000 and your goal is to generate enough income to replace it, not replacing 100 percent of it, but realistically something like 80 percent. Meaning that you will want to accumulate enough money that it can replace 80 percent of your income. Generally, advisors have used a 4 percent rule, in terms of using that percentage of your accumulated assets to draw upon. So, in this example of present day $100,000, accumulating $2,000,000 could generate $80,000 per year. This may seem really lofty, but it isn’t too far fetched, depending on what stage of saving you are in.
Sticking with the example of $100,000 income and achieving a replacement income of $80,000 in the future, we need to determine how much we need to save per year and monthly versus the “status-quo” of a percentage. In this case, using a sinking fund strategy helps calculate the payment you would have to make to yourself based on the future value of your accumulation pot of retirement gold. With a 30 year saving time horizon, you would need to be saving $23,584.44 per year or $1,965.37 per month, and/or average a 6 percent return to achieve $2,000,000.
Depending on your income, such as having a combined income, it would be best to split between spouses. The reason for this has to do with how much you can personally save into a retirement account. The maximum allowable saving amount by an employee is $19,500 for 2020 and this generally is adjusted every year. In the example I used, a person under 50 would not be able to contribute more than the allowable amount. Those that are 50 years of age would be allowed to make “catch up” contributions.
Your situation and circumstances are unique in terms of where you are in life and how much you have saved. Basically, this means that you should take a complete assessment of your finances to formulate a strategy that allows for you to budget and manage your expenses. This idea of determining an acculturation goal is different than that of the traditional ideology of sticking to a percentage amount. I find it to be flawed and misguided because it hasn’t led to a healthy accumulation of retirement assets that are sustainable.
Retirement plan sponsors, your employers that are offering retirement plans, need to make a shift in adding more comprehensive planning tools that can help employees better understand their unique situation. One such benefit is having a Financial Wellness Benefit that can coach employees to better understand their financial situation and the steps to take to accumulate their retirement savings while reducing their debt and/or managing life’s unique circumstances. Similar to an Employee Assistance Program, a Financial Wellness Program can help educate your employees and give clear guidance to stay the course.
Retirement plan sponsors and leaders should also allow or consider access to independent financial advice. An advisor that acts as a fiduciary can help personally coach and guide an employee to be consistent and better understand their corporate benefits as well as how they fit with their personal lives. A financial advisor that has a comprehensive understanding of their employer benefits and their personal financial resources is better equipped to create financial synergy. Vanguard’s Alpha Study in 2016 found that a relationship with an advisor added 3 percent higher return than those who didn’t work with an advisor. The benefits of this helps employees with behavior coaching.
If you are an employer, employee or HR professional and are curious about the effectiveness of your retirement plan, book a quick chat in our contact section.