Save More Tomorrow: 401 (k) Strategies

Even when employees are lucky enough to have a 401 (k) plan offered by their employer, they are not saving enough to have sufficient funds in their savings account to maintain their lifestyles after they retire.  This sobering fact is from the Center of Retirement Research for the Wall Street Journal using data compiled by the Federal Reserve.

I have written about the large change that has occurred for most workers of private large companies in the United States regarding their retirement income planning “What happened to Pensions?“.  The old days were dominated by the companies supporting the worker and their families via a pension payment for as long as they lived in retirement.

Saving strategies for 401k plansAll of that changed when the companies began to offer 401 (k) plans which encouraged employees to save for their own retirement.  With this change, employees were expected to invest their savings in investment options selected by the employer.  However, some aspects of this roll out have made it hard for workers to reach sufficient levels of savings.

The companies usually set the target of 3% for the savings rate that would be invested pre-tax into the 401 (k) plan (75% of the companies use this default rate).  Some generous companies even matched the first 3% of the employees’ contribution either by a half percentage per 1% or even 1% for 1%.

That created the first problem for most employees.  It set the expectation that 3% was the magical percentage which would allow for them to meet their goals.  Not so.   According to Financial Engines report in 2010, almost three quarters of 401(k) plan participants are not saving enough to ensure a comfortable retirement.

A book entitled “Save More Tomorrow” by Shlomo Benartzi discusses practical solutions to improve 401 (k) plans.  The book is geared towards people responsible for corporate retirement plans of all sizes, but I believe some of his suggestions can help participants right now.

He suggests that the savings rate percentage that should be targeted by young employees be 4% or 5%. So if you are currently just beginning in the workforce and joining a plan, determine if you can increase your saving rate to 5% of your gross income.  Over time, the percentage needs to increase to a minimum of 10% as per Shlomo.  He states that this rate was determined from academic literature, consulting with experts and asking plan participants themselves what was the “ideal” savings rate.  But how can this increase in the savings rate occur?

One of his ideas advocates that the employees increase the percentage saved over time.   This increase can occur as employees are given salary increases that they increase the percentage saved in their 401 (k) plan.  It works because you never adjust your lifestyle to the full salary increase.

Shlomo would like to have this become a feature of 401k plans.  And while that is a good idea, why wait?  If your company is not offering this automatic escalation,  I strongly encourage that you consider putting this idea into practice for your own retirement.  Using the Save More Tomorrow approach,  you do not have to give anything up today and just increase the percentage saved in your 401k as you receive future pay increases, so you won’t feel the same sense of sacrifice that you otherwise would.

These actions today will help you “Save More Tomorrow”.  This increase every year will help you take concrete actions to avoid a common fear – not being able to afford living expenses in your old age.  As my earlier post discussed, it is deciding that the future benefit is more important than the current consumption.  To read further on the benefits of delayed gratification read my post on the subject  Investors and the Marshmallows Test

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About Dan Crimmins

Dan Crimmins, co-founder of Crimmins Wealth Management, is a financial coach and fee only financial planner. Have a financial question? ASK DAN

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