Saving for retirement at an early age is likely more important today than at any other time in recent history. However, unlike the baby boomers, many generation X and Y individuals are not focused on retirement but instead are focused on starting families and solidifying careers. As such, many people are merely just pushing off the costs of saving for retirement into the not too distant future. This delay in saving for retirement could have substantial negative effects on their financial well-being. While many people find it difficult to plan for retirement just as they are beginning their careers, there are a variety of simple steps that can significantly improve the retirement preparedness of both generation X and Y.
Before we can really examine the steps to improve the generation X and Y retirement security, it is important to understand some of the reasons causing individuals to delay saving for retirement. First, there are what I call “natural retirement savings delay expenses” such as: education; families; home-ownership; and beginning a career. The lack of income and higher priority of other life events often takes precedent over saving for retirement at early ages. However, many of these “natural” expenses are being exacerbated by current market conditions, further delaying young individuals from saving.
For instance, individuals from generation X and Y are going to be carrying more education related debt into retirement and later stages of life than any other previous generation. This is a significant expense that other generations just did not have to account for when developing a budget and saving for retirement. Coupled with the higher education debt expenses is the fact that the generation X and Y groups have struggled to find careers at an early stage in life. As such, their careers have been delayed to a much later age than previous generations. This has created both a reduced income level and an increased expense for those generation X and Y people trying to save for retirement.
Three other important factors have negatively impacted their ability to be financially prepared for retirement. First, the decline in defined benefit plans and a move to defined contribution plans, like a 401(k), has reduced the certainty of obtaining specific employee sponsored retirement benefits. Instead, much of the onus on retirement savings is being shifted away from the employer and onto the individual. Secondly, movement between jobs is much more common, which can also reduce employer provided retirement benefits. Lastly, it is not far-fetched to expect Social Security benefits to be significantly reduced for this group. Ultimately, this reduction in two-thirds of the traditional sources for retirement income will place a larger burden on individuals to save for retirement.
While the multitude of factors can be daunting, there are a variety of simple steps that can be followed to increase retirement security. First, when people move from job to job it is important to roll over the money in your qualified retirement plan into either the new job’s plan or into an IRA. Too many people pull this money out when they switch jobs at an early age, causing a significant loss in savings. Even rolling over a few thousand dollars can have a significant impact on one’s retirement readiness. For example, if you were to roll over $3,500 from a qualified retirement account at age 30 instead of taking it out when you switch jobs, you would have $19,306 dollars at age 65, assuming the amount grew at an annual rate of 5-percent. If you were to instead just take this money out of your plan, you would only net $2,275 dollars after an assumed 25-percent income tax and a 10-percent early withdrawal penalty tax.
Another savings tip is to make sure you are getting the most of your employee benefits. Many people do not receive the full matching amount from their employer in their qualified retirement plan. Roughly 53-percent of workers under age thirty do not contribute enough to their 401(k) plan to receive the full employer match, as opposed to only 39-percent of the population as a whole. Even though deferring salary into a qualified retirement plan reduces your paycheck, it is generating your more money each week than otherwise. Furthermore, because you are deferring taxes on 401(k) contributions, you might contribute 6-percent to your plan but only see your paycheck reduced by 4.5%. If your company offers a 401(k) plan that matches 50-percent of up to 6-percent of what you defer in salary, you should try your best to defer 6-percent of your salary to receive the full benefit being offered.
Additionally, the power of saving early cannot be underestimated. Several years ago Roger Ibbotson and several other authors wrote an article entitled National Savings Rate Guidelines for Individuals. This article noted the appropriate savings rates for individuals of different ages. Take an individual with a $40,000 salary looking to replace 80 percent of his or her salary in retirement. If this individual started saving at age 25, the savings rate would be 8.2 percent of his or her salary. However, if the person did not start saving to age 40, the savings rate would be 14.8-percent. Professor Wade Pfau has also demonstrated the benefits of saving early in life as the safe savings rate will be lower the sooner you start to save for retirement. This is because the earlier you start saving, the more time compounding investment interest effect has to take hold.
While many people in generation X and Y are not focused on retirement planning and savings, it is the right time to do so. Saving early is extremely beneficial, especially with the unique challenges facing current generations. Saving early also means you will not have to save as much later on in life. While saving for retirement at a young age might make life a little bit more financially difficult for a few years it will really pay off later in life.