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What!? Save tomorrow instead?

By Barbara Whelehan ·
Saturday, July 20, 2013
Posted: 6 am ET

What's the optimal savings rate to contribute to a workplace retirement plan to ensure you'll have enough money in retirement? I conducted an informal poll among several financial planners, and most came up with a range of 10 percent to 15 percent, with emphasis on the latter.

"People need to save at least 5 (percent) to 7 percent for themselves, another 3 to 5 percent for future health care costs, not to mention potential out-of-pocket extras like helping adult children or caring for a sick parent or sibling, requiring another 1 (percent) to 3 percent," says retirement expert Robert Laura, author of "Naked Retirement."

"All told, 12 (percent) to 15 percent should become the norm for those wishing to exit the workforce before 65 and maintain a similar standard of living," he adds.

Christine Fahlund, senior financial planner and vice president of T. Rowe Price Investment Services, says you should contribute "at least 15 percent of salary, including any employer match. If you are highly compensated or expect to be, you should probably be contributing closer to 20 percent instead."

CFP professional Leslie Corcoran of Family First Financial Planning says 15 percent is safer than 10 percent. "I always recommend to new graduates to start off at 15 percent, and then they never feel it later."

This is sound advice, and anyone following it will be well-served. But how many people embrace the idea of spending less today to save more? Unfortunately, not many.

A successful procrastination strategy

As Bankrate's story on the dire retirement situation of baby boomers reveals, the personal savings rate of Americans has fallen over the years to its current level of about 4 percent of disposable income. Pathetic!

One of the financial planners I reached out to, Michael Kitces, acknowledges that Americans have a tough time curbing their spending and advocates a different tactic. "I'm actually very negative on the whole 'percentage of income' as an approach to saving," says the director of research at Pinnacle Advisory Group in Columbia, Md.

His strategy won't work for boomers, but Kitces writes in a recent blog post that younger savers -- Generations X and Y -- should be encouraged to "save more tomorrow instead." They can do this by committing to save most of their future raises. For example, if they get a 4 percent raise, they can allocate 3 percent to the 401(k) plan and allow themselves a 1 percent bump-up in spending.

This "save more tomorrow," or "SMarT," approach, was found to be wildly successful in a study by behavioral finance researchers Shlomo Benartzi and Richard Thaler. They discovered that few people (28 percent) were willing to increase their level of savings immediately, but, "A whopping 78 percent of those who refused to increase their savings now were willing to increase their savings by 3 percent per year in the future," writes Kitces. The results were astonishing. Over four years, those who increased their savings rate as a percentage of income elevated it from 4.4 percent to 8.8 percent -- not bad. But those who committed to saving future raises were at a "whopping 13.6 percent savings rate."

Meanwhile, the SMarT savers don't have to make lifestyle changes to accommodate their increased savings. More significantly, their lifestyle expenses don't increase substantially as they get more raises, which makes it that much easier to maintain their lifestyle once they reach retirement.

The only problem with the SMarT approach is implementation. In the study by Benartzi and Thaler, once workers committed to a particular savings strategy, it was automatically adjusted for them. Meanwhile, in the real world, workers would have to fight inertia and notify their plan administrators and manually authorize the savings increases each year themselves by filling out the paperwork or going online. Though it takes less than 10 minutes, somehow this is a huge hurdle for most people to overcome.

Nevertheless, younger people who are truly motivated to work toward retirement freedom can greatly benefit by following this SMarT approach to retirement planning.


Follow me on Twitter: @BWhelehan.

Barbara Whelehan is a co-author of "Future Millionaires' Guidebook," an e-book for Gen Y by Bankrate editors and reporters. It is available at Amazon, Barnes & Noble, iBookstore and other e-book retailers.

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