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.