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Saving just 1% more can go a long way

Increasing your savings by just 1% a year could mean bigger payoffs in retirement.

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Would you be willing to bring your lunch to work once a week if it meant you could go out to dinner once a week in retirement? Would you forgo a movie night out if the savings could pay your monthly cable bill in retirement?

Putting just 1% more of your salary each month into a qualified retirement plan could make a palpable difference in your ability to afford the retirement you want. And finding that additional 1% can be as easy as packing a bag lunch, adjusting your home thermostat, or having a stay-at-home date night once a month.

“The retirement savings mountain might appear imposing from a distance, but the reality is that the climb isn't as steep as it looks,” says Beth McHugh, vice president of Market Insights at Fidelity. “Thanks to the potential power of compound earnings; the tax advantages of qualified retirement savings accounts; and, for many people, a company match on contributions to workplace savings plans, small steps can turn into big strides.”

How big? Let’s look at two hypothetical 401(k) investors. Both investors accept our challenge to invest 1% a year more of their salary in their 401(k) until retirement at age 67. For illustrative purposes, we assume that their salaries grow 1.5% a year, adjusted for inflation, boosting monthly contribution amounts along the way. We also assume two long-term compounded annual hypothetical rates of return: 5.5%, which we think aligns roughly with an average long-term return for a conservative-to-balanced asset mix, and 7.0% for a more growth-focused asset mix.1

Meet Bob and Sally

Bob is 25 years old and earns $40,000 a year as a software designer. Eager to save more, Bob increases his salary deferral by 1%, boosting his initial monthly saving by $33 a month, to $133. He also invests in a growth-oriented portfolio. Assuming a 7.0% annual nominal return over his lifetime, that initial $33 a month in extra savings generates a potential $330 a month in retirement income. That’s almost $4,000 a year, and more than $99,000 over 25 years in retirement. (Results are in today’s pretax dollars.)

Now consider Sally. She’s 35 years old and earning $60,000 as a financial analyst. Like Bob, she too is concerned about her future. So, she increases her deferral, bumping up her contributions by $50 a month, to $350. With a balanced asset mix, Sally’s portfolio generates 5.5% annual nominal returns. By the time she retires at 67, her extra $50 in monthly savings generates a potential $180 a month more in retirement income, which is $2,160 a year, and $54,000 over 25 years.2

Notice the striking difference between Bob and Sally’s retirement paychecks, illustrated in the table below. Even though initially Bob put away $17 less a month than Sally, his extra 1% in savings earned him $150 more per month than Sally’s. Over 25 years of retirement, that difference could add up to $45,000. The reason: Bob started saving 10 years earlier than Sally, and earned higher returns (7.0% versus 5.5% nominal returns).

Saving in an individual retirement account (IRA) is another great way to build savings for income in retirement. For example, a 25-year-old who saves a consistent $50 each month in an IRA until age 67, and earns a hypothetical 7% a year compounded, could receive an estimated $390 in additional pretax monthly retirement income.3 But waiting until age 35 reduces that additional monthly income in retirement nearly in half, thus illustrating the benefit of starting to defer as early as possible from your salary.4

What a $50 increase in savings now could mean for retirement income
Current Age Additional Consistent Monthly
"Cost" for IRA Investor
Assumed Rate of Return Potential Increase to Monthly Pre-Tax Retirement Paycheck
25 $50 7.0% $390
5.5% $230
35 $50 7.0% $220
5.5% $140

“The key is to defer early, and save tax efficiently,” says John Sweeney, executive vice president at Fidelity Investments. “That means maxing out on your 401(k) and IRA contributions, and then considering other tax-smart savings vehicles, including health savings accounts and, when applicable, variable annuities, deferred compensation, and taxable brokerage accounts, too.”

Are you saving enough?

Retirement saving by the numbers

$80,600 11% from Q2 2012
Average 401(k) balance, as of Q2 2013
 
$81,100 53% from 2008 low
Average IRA balance, as of 2012 tax year

Americans generally are saving more—but still not enough. According to Fidelity’s analysis of 401(k) data,5 the average 401(k) balance remained relatively steady in the second quarter of 20136 over the previous quarter, ending at $80,600, and up nearly 11% from $72,800 a year earlier. For employees who were continuously employed and in a 401(k) plan for the last 10 years, the average balance rose to $211,800, up 19% from a year ago.7 Additionally, for the past four years, more employees increased their 401(k) savings rate8 than decreased it.

Meanwhile, the average IRA balance reached a five-year high of $81,100 at the end of tax-year 2012,9 a 53% increase from the 2008 low, according to a recent Fidelity analysis. Another positive sign: Total contributions to Fidelity IRAs have increased 7.5% from tax-year 2008 to tax-year 2012, with the average IRA contribution reaching $3,920 in tax-year 2012.

But are you on track to meet your retirement goals?

Everyone’s situation is unique, of course. So, take the time to assess your own retirement readiness by using Retirement Quick Check, which has the added benefit of letting you estimate how additional savings can help improve your income in retirement.

If you’re behind, don’t fret. Remember, planning for retirement is a journey. At Fidelity, we recommend saving a total of at least 10% to 15% of your income toward retirement (this includes any amount your employer contributes). But few people get there overnight. The key is to get a plan and ratchet up your saving over time. To find opportunities to save, consider keeping a one-month spending diary to track where your money is going. You may be surprised at what you find.

“The surest way to stay on track toward a financially secure retirement is to start early, save regularly, increase the amount you save as your income increases, and adjust your asset allocation along the way,” says Fidelity’s McHugh. “Then when you’re enjoying life in retirement, chances are you’re going to look back fondly at those brown-bag lunches you brought to work.”

Learn more

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1. Hypothetical examples assume that the individual saves until retirement age 67, lives through age 93, and receives a 1.5% real (inflation-adjusted) increase in wages per year. Rates of return are nominal 5.5% and 7.0%, respectively; the 5.5% return consists of 3.2% real return and 2.3% inflation while the 7.0% return consists of 4.7% real return and 2.3% inflation. These illustrations assume that deferral percentage rates stay constant throughout the participants’ working careers. Estimated increases in retirement monthly income are in constant 2013 dollars. It is assumed that upon retirement the real (inflation-adjusted) dollar amount is withdrawn annually through age 93, and that the participant took no loans or hardship withdrawals from his or her workplace plan. The maximum annual qualified 401(k) retirement plan employee contribution limit in 2013 is $17,500 (or $23,000 if age is 50 or older). All dollars shown (including increases to monthly retirement paycheck) are pretax dollars. Upon distribution, applicable federal, state, and local taxes are due. No federal, state, or local taxes; inflation; or account fees or expenses were considered. If they were, returns and monthly increases would be lower.
2. $33 per month starting at age 26, which would increase along with assumed real wage increases of 1.5% annually for an average contribution of $46 monthly over the participant’s working life to age 67. $50 per month starting at age 36, which would increase along with assumed real wage increases of 1.5% annually, for an average of $64 monthly over the participant’s working life to age 67.
3. Estimated increases in retirement monthly income are in constant 2013 dollars. It is assumed that upon retirement the real (inflation-adjusted) dollar amount is withdrawn annually through age 93.
4. Ibid. 3.
5. Fidelity analysis of 20,700 corporate direct contribution (DC) plans (including advisor-sold DC plans) and 12.4 million participants, as of June 30, 2013.
6. Average balance as of first-quarter 2013 was $80,900.
7. The average account balance one year prior (June 30, 2012) of participants who were 10-year continuous participants as of June 30, 2012, was $178,700.
8. Employee elective deferral rate, not inclusive of any employer deferrals.
9. January 1, 2012, through April 30, 2013.
Retirement Quick Check is an educational tool.
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