Real life has a way of challenging the most comprehensive research and the best of plans. The reality is for most people, their 20s and early 30s are dedicated to building a family and managing risks by acquiring life, disability, and property insurance. All of these take priority over saving for retirement, but those who can afford both risk management and retirement saving in their 20s will substantially reduce their saving requirement in later years. If we start by helping clients understand how much they need to save in a generic sense, the daunting task of the 30- or 40-year plan will become more digestible in smaller bite sized pieces.
Most people would be stunned to hear they should save 15 percent of their pay, but that’s what the research suggests if they still have 30 years left before they retire. If they haven’t yet started and want to retire in 20 years, they should double their savings rate. If they are still young and want to save for 40 years, they can cut the safe savings rate in half.
Setting a savings goal for the next five years should be within everyone’s capacity. Actually meeting a goal requires practice. If the client is saving just 5 percent of their income, then the first step is to find ways they can increase the percentage towards 15 percent rather than have them focus on the millions they need to accumulate by retirement.
One might ask, if this is a guide about retirement, why are we discussing five-year savings plans? I’ve been providing these services for almost 35 years now, and my most successful retirees were those who saved early and saved often (teachers were amazingly good at this). Preparing a 40-year retirement projection for a 35-year-old couple likely won’t motivate them to save because the numbers are too large and the goal too distant. Bring it closer to home and show them how to achieve goals that are currently within their reach.
I like to start savings discussions with an old economic principle: the marginal propensity to consume.
That is, if I got a 4 percent raise, how much would I spend and how much would I save? If the answer is that I would spend all of it, then I have a propensity to consume of 1. It should be obvious to all that that approach leaves little room for saving. So, establishing the goal to save 15 percent of income also requires that the client save 15 percent of every raise.
But what if their raise is below the inflation rate?
Although most advisers’ clients will tend to have income greater than the typical American, you may have clients in this situation. If it is likely that your client will rarely have raises in excess of inflation, then your discussion must focus on their current lifestyle all the more because their spending may already be too high. Having this discussion may, in fact, inspire a client who otherwise is satisfied with their current situation to look for ways to change their future by adding college courses or vocational training to their five-year plan. Your discussions may be the first time your client has confronted their wage growth potential. By framing their future with a five-year plan to change their income and savings growth potential, you may save this client from living in a statistical dead end that will affect them the rest of their lives.
The U.S. Bureau of Labor Statistics updates industries with the fastest growing and most rapidly declining employment. Their "Industry Employment and Output Projections to 2022" report shows that health care, technology, and social assistance jobs, followed by professional and business services, will be the fastest growing segments of our economy. Manufacturing, of all types, is forecast to be the most rapidly declining sector.
When young clients are in a career that offers no chance for a better life, making their career choice a central focus of the first five-year plan could lead them to new opportunities they simply could not see on their own.
Help your clients learn how to save
It is clear many clients don’t know how much to save, but just as many don’t really know how to save.
In my opinion, most people don’t know how to save because they don’t know where they are spending their money. Advisers should encourage clients to keep a record of their monthly and annual expenses.
Clients will likely resist the effort it takes to truly track spending, but I know of no other way to actually understand where the money goes, and without that knowledge it is very hard to find ways to save. I generally don’t make guarantees, but I can guarantee any client that makes the effort to track their spending will identify areas where they can make spending cuts.
Assume the recordkeeping does the job and the client commits to saving $500 per month, which is 15 percent of their $40,000 annual wage. The following is a short list of good savings techniques that most people can implement with a bit of discipline.
- Save at least enough in your employer’s 401(k) plan to receive the maximum matching contribution. The employer match is truly free money and counts towards the goal.
- If eligible, and the income tax strategy makes sense, fund Roth IRAs.
- As a next step, if you can, save the maximum that your employer’s 401(k) plan allows.
- If your employer allows, set up an automatic deduction from your paycheck that goes straight to your savings account at your local bank, credit union, or mutual fund for additional savings beyond the retirement accounts. This would be a good way to acquire down payments for big ticket items.
- Set up an IRA at an institution that accepts monthly deposits for an amount that fits your budget.
- Speaking of budgets, create one and make it reasonable and achievable. A budget can create discipline much like an investment policy statement or withdrawal policy statement by reinforcing your goals. A budget is also a precursor to establishing a retirement savings policy statement.
- If you want to buy a big ticket item, try to save a larger down payment to reduce the monthly debt payments. Establish a dollar goal and a timetable that you can meet. Saving for a down payment also creates discipline and satisfaction when the goal is met.
- If you prefer prepaying your home mortgage with raises and bonuses, that works as well. This type of debt reduction is the same as saving; it’s just on the other side of the balance sheet.
- Each time you succeed in achieving a savings goal, your skill improves and the next goal will be easier to reach.
- Work towards the 15 percent savings rate and don’t stop until you have done so. When you have met that goal, consider whether increasing your savings rate to 20 percent is within your grasp.
- Create a "savings ritual" for children and grandchildren.
- Finally, whenever a savings goal is met, the entire savings process should be reviewed to make sure priorities are reset and ranked to avoid consumption by default.
Editor’s note: Excerpted with permission from The CPA’s Guide to Practical Retirement Planning © 2015, AICPA.
James A. Shambo , CPA/PFS, is president of Lifetime Planning Concepts Inc.