The Slow and Steady Strategy to Contributing 10% Toward Your Retirement
We're all told to save, save, save for the future, a rainy day, and for our retirement. The cliche's roll off the tongue of usually from those older than us and who have either followed the advice successfully, or who are learning the lesson the hard way. And if you're feeling the desire to increase your retirement contributions to avoid a short-fall in the future, then might I suggest a "slow-and-steady" approach to ramping up your contributions?
One of the easiest ways to make sure you put your raise to effective use is to simultaneously increase your retirement contributions by one percent. You won't yet have increased your lifestyle when the raise comes, and a one percent increase won't smother your entire raise. It will only take a portion of it and will make a big impact on your retirement in the long-run.
First, let's take a look at a few of the retirement plans you might be dealing with...
Types of Retirement Plans
There are a handful of plans defined in the IRS code making up an alphanumeric soup. You don’t necessarily need to be familiar with them all, but it helps to be aware that there’s more than just a 401(k) out there. Here are a handful of links to various retirement plans as described on the IRS website.
- Individual Retirement Arrangements (IRAs)
- Roth IRAs
- 401(k) Plans
- 403(b) Plans
- SIMPLE IRA Plans (Savings Incentive Match Plans for Employees)
- SEP Plans (Simplified Employee Pension)
- SARSEP Plans (Salary Reduction Simplified Employee Pension)
- Payroll Deduction IRAs
- Profit-Sharing Plans
- Defined Benefit Plans
- Money Purchase Plans
- Employee Stock Ownership Plans (ESOPs)
- Governmental Plans
- 457 Plans
- 409A Nonqualified Deferred Compensation Plans
Each of these have their own specifics, but in general, you’ll want to understand what type of plan your employer offers and the details of the benefits (is there a match?). No worries if your employer doesn't offer a plan, or if you are self-employed, there are options for you as well.
Take the Match
The first thing you should do as soon as you are eligible is to get into your company retirement plan at the match level. That might be 3% - 6% or even higher depending on how generous your company is.
This ensures you are getting that “free” money everyone talks about. This gives you a nice base level of retirement savings and a peace of mind knowing you’re getting an instant return on the dollars going in (employer match contributions).
Beyond the Match
An easy way to consistently increase your contributions over time is to increase your contributions by one percent every year until you get to 10%. Once you get to 10% it would be a good time to find a financial planner to ensure you are on track not only with retirement, but with the rest of your life’s goals.
If you switch jobs, hopefully it’s for a salary increase and in that case, for sure get into the new plan with the same percentage or better than you left. If you received an increase in salary with the job change, increase your retirement plan contributions as well when you enter the new plan.
This will help you stay on an incrementally increasing contribution track. Your future self will thank you.
Say you make $50,000 per year and your company plan offers a 3% match if you contribute 3%. Here’s how applying the 1% increase rule shakes out over the first five years of employment with a 3% raise each year.
- Year 1 / salary $50,000: your contribution (3%) $1,500 + employer contribution $1,500 = $3,000
- Year 2 / salary $51,500: your contribution (4%) $2,060 + employer contribution $1,545 = $3,605
- Year 3 / salary $53,045: your contribution (5%) $2,652.25 + employer contribution $1,591.35 = $4,243.60
- Year 4 / salary $54,636: your contribution (6%) $3,278.16 + employer contribution $1,639.08 = $4,917.24
- Year 5 / salary $56,275: your contribution (7%) $3,939.25 + employer contribution $1,688.25 = $5,627.50
- Total contributions in the first five years of employment = $21,393.34
These calculations don’t consider investment growth of the dollars (could go up or down). Your 7% plus your employer match of 3% makes your total contributions 10% per year.
Obviously, the trigger point for increasing the contributions is when you get a raise. At the point you know your raise is coming, talk with your HR folks and increase your contributions by 1%. As job changes come along, be sure to keep your contributions at the level you had them.
You’ll be putting more and more money away for retirement as time goes on. And if you start young, keep your spending in check as it compares to your income, you should have peace of mind knowing you are saving aggressively for your future and living on less than you make.
This strategy works well when starting out on a smaller income as it allows you flexibility to grow into a more aggressive saver. The alternative of starting at 10% from the start can be a hard pill to swallow for young adults starting out in their careers. As with most things in life, there is more than one way to get there. Find the way that works best for you and stick with it.