Why the ‘Save 10% for Retirement’ Rule Doesn’t Always Work

To keep saving simple, many retirement experts and financial planners tout a general 10% rule for most savers: If you start saving at least 10% of your income in your 20s, you should have plenty saved up by the time you’re ready to retire.

Why save for retirement?

Social Security might not be around to help you make ends meet in retirement; that’s even more likely for millennials and the cohorts that follow. With the nation’s current birth and death rates, it’s estimated that Social Security funds will be exhausted by 2034.

Whether or not the future retirees of America will have Social Security to rely on, their benefit check alone likely won’t be enough to meet all of their needs in retirement.

According to the U.S. Bureau of Labor Statistics, retired households need to bring an average $42,478 to meet their annual expenses.

And yet, as of March 2017, the average monthly Social Security benefit for retirees was $1,365.35, or about $16,384 annually. That’s only slightly more than the U.S. Census Bureau’s 2016 poverty threshold for two-person households 65 and older ($16,480). Even in households where two spouses are receiving Social Security income, that’s still less than $32,000 per year.

That’s why it’s so important for workers to set additional income aside during their working years. When Social Security falls short, those extra savings will be essential.

Who does the 10% retirement rule work best for?

It’s likely that 10% became the rule of thumb simply because it’s easy to remember and makes the mental math a lot easier. But it’s important to understand who the rule is targeting: younger workers.

Since younger workers have more time to let their money grow, they can afford to save a bit less in their early days. But the advice changes as workers’ savings windows narrow with age. A 40-something worker, for example, who never saved for retirement may be encouraged to save twice as much for retirement since they have a shorter timetable.

“Ten percent may be enough, it may not be enough, and it may even be too much,” depending on your age and financial picture, says Amy Jo Lauber, a certified financial planner in Buffalo, N.Y. Someone paying off student loans or high-interest credit cards simply may not be able to put away 10% of their income.

It gets increasingly complicated when you consider your personal income and ability to save as well as your retirement goals.

“Typically, younger clients do not have complex situations and can get by with simple strategies. Once there are competing priorities, such as saving for a home, kids, and kids’ college, then things get complicated and more sophisticated strategies are required,” says Howard Pressman, a certified financial planner and partner at Egan, Berger & Weiner.

As Pressman suggests, you might need to tweak the rule if you’re starting to stash away retirement funds at an earlier or later age or want to put more money away now for a more lavish retirement.

Timing is everything

This chart from JP Morgan’s 2017 Guide to Retirement demonstrates the power of saving early for retirement.

At a modest 6% annual growth rate, Consistent Chloe, a 25-year-old who puts away $5,000 a year until she reaches age 65 should have a retirement account balance of more than $820,000, according to the bank. And when all’s said and done, only $200,000 would have come out of her own pocket — the rest would have resulted from the power of compounding interest.

In comparison, Nervous Noah, a more timid 25-year-old saver, could put away the same $5,000 a year in a savings account earning far less annual interest on his cash. After the same 40-year period, he would only have a balance of $308,050.

Investing earlier can bring even greater success. If a person starts putting away $5,000 a year at 20, growing at 6%, their balance at 65 would be about $1,132,549, which we calculated using the U.S. Securities and Exchange Commission’s compound interest calculator. That’s more than $300,000 added to Consistent Chloe’s retirement balance for beginning just two years earlier.

The final balance at 65 drops below $1 million for anyone starting after 25. As you can see above, those who begin saving will have less and less to live on in retirement.

7 retirement savings tips

  1. Start early

The emphasis of this rule is starting early. The earlier you save, the more you can take advantage of compound interest.

“Compounding is earning interest on interest earned in prior periods and is the most powerful force in all of finance,” says Pressman. To make the most of this rule, start saving 10% of your income for retirement by the time you turn 25.
Start by maxing out your 401(k) or IRA contribution limits for the year. If you still have additional funds, it might be time to meet with a financial planner to find out how to best invest your surplus.

  1. Know your options

The best place to stash retirement savings is either an IRA or a 401(k). Your money simply won’t grow enough to beat inflation if you leave it in a low-interest-bearing account like a checking or savings account.

  1. Make debt and emergency savings a priority

“Before anyone starts focusing on retirement saving, the first thing they should do is to establish an emergency cash reserve. This is to protect them from a job loss, a health emergency, or even an expensive car repair,” says Pressman. He recommends saving three to six month’s worth of expenses in a savings account.

If placing 10% of your income in a retirement account is too much of an ask because you have more pressing financial obligations like higher-interest debts, or don’t earn enough to cover your expenses, you should address those before increasing your retirement contribution.

Generally speaking, if the interest rate on any debts you owe is higher than what you’d earn on your retirement savings, you’ll make more progress toward your financial goals by addressing the higher-interest debt first.

  1. Plan differently if you have irregular income

Lauber says those who are freelancing and cobbling together a living may need to put several financial policies in place to help them navigate with irregular income.

“The 10% rule works for them but only if other measures are in place for the immediate day-to-day needs,” says Lauber. You can still create a budget with irregular income, but you might need to approach retirement saving more aggressively when income is higher, and strategize your saving to compensate for months when income is nonexistent or low. Find more tips on how to manage irregular income here.

  1. Make the most of your match

Don’t leave free money on the table. If your employer offers to match your contribution, Kristi Sullivan, a certified financial planner with Sullivan Financial Planning in Denver, Colo., advises individuals to save as much as your employer matches immediately or 6% if there is not a match. That way, you won’t miss out on free additions to your retirement nest egg.

  1. Automate your contribution

Out of sight, out of mind. Automate your retirement contribution to ensure you pay yourself first.

“Typically, once it’s done through payroll deduction, the person seldom misses it,” says Lauber.

  1. Check in regularly

Don’t just “set it and forget it.” Mark R. Morley, certified financial planner and president of Warburton Capital Management, stresses “clients must be ‘invested’ in their own plan.”

He says to check periodically on your retirement account and make adjustments where necessary. If you have a financial adviser, you may want to schedule regular progress meetings.

“When a client is engaged in their own plan and can see real results, we can work on the two variables that affect the retirement accounts: time and money,” says Morley.

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