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Retirement Planning > Saving for Retirement

More Money, More Problems: How to Help Clients Handle a Raise

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The next time your clients get a raise, advise them to increase their contribution rate to their retirement plan. Otherwise they risk not saving enough for retirement.

That  may sound convoluted because even if they don’t change their retirement plan contribution rate they would be saving more money simply because their salary had increased. But according to a new report from Morningstar, titled More Money, More Problems, people tend to raise their standard of living after a salary increase — a tendency known as “lifestyle creep.” If they continue to save at the same rate as before their raise, they may not be able to fund their now more expensive lifestyle later in life.

“If you’re saving 10%, that’s wonderful,” explains Steve Wendel, head of behavioral science at Morningstar and one of the authors of the report. “You’re now saving 10% of a larger amount, but you haven’t increased your prior savings, your existing assets by the amount of the raise. … The lesson: Increase your savings as part of the raise.”

But by how much? Morningstar tested three different potential solutions in an analysis of 1,619 households using data from the Federal Reserve’s 2016 Survey of Consumer Finances and focusing on the question: How much of a 5% raise would need to be saved to match pre- and post-raise retirement standards?

Three choices were tested:

  • Spend twice your years to retirement and save the rest — if you’re going to retire in 10 years, spend 20% and save 80% of the raise
  • Save your age as a percentage of the raise — 50-year-old saves 50% of the raise
  • Save at least one-third of your raise.

The first choice was the most successful, but the second choice worked up until age 45, and the third, up until age 35.

Implementing any of the three would help boost retirement savings. “Everyone needs to start planning for the rise,” according to the Morningstar report. That’s where advisors can help. They can encourage clients to commit in advance to saving a good portion of their raises in order to adequately fund their retirement accounts.

That commitment is at the heart of the Save More Tomorrow program developed by behavioral economists Richard Thaler, winner of the Nobel prize, and Shlomo Benartzi, which many employers use and which formed the basis for automatic escalation programs in 401(k) plans. When the economists first tested the program in the early 2000s — with the help of a financial advisor — they found that most workers rejected a request to increase their savings rate by 5 percentage points, often because they didn’t think they could afford it. But when the workers were asked to commit to saving more in future, 78% said they could. Four years after they joined the program, their average savings rate soared from 3.5% to 13.6%.

The Save More Tomorrow program helps workers commit to a higher savings rate, but it doesn’t provide guidance about how much to save, according to Morningstar. Its savings rate recommendations can help with that.

— Check out How You Can Hack Your Retirement Plan on ThinkAdvisor.


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