How a Salary Increase Can Threaten Retirement

It’s a common enough habit: You get a raise, you can suddenly afford to spend more—and you do.

But if instead of boosting spending each time a raise hits their paychecks, workers socked that extra money away into their retirement savings, says a report from Morningstar, they’d be much better prepared for retirement—in more ways than one.

Higher income can actually make it tougher to prepare adequately for retirement, the report points out. Not only do people not generally increase their retirement savings rate with each raise, but their higher income contributes to lifestyle creep—a gradually rising standard of living that costs more and thus is more difficult to maintain on the likely restricted income that accompanies retirement.

Retirement assets don’t rise at the same rate as income—indeed, if at all—and not only won’t keep up with new retirement expectations, but may actually shrink relative to them. And the higher up the income scale a worker gets, the less likely it is that Social Security, in particular, will provide the same proportion of yearly income that it did at that worker’s former (and lower) rate of pay, since income provided by Social Security is capped well below the income received by highly paid workers.

Three savings strategies tested for the report were: Save the percentage of the raise that equals twice the number of years until you plan to retire; save your age as a percentage of the raise; and save at least 33 percent of your raise. Under the first strategy, someone planning to retire in 10 years should save at least 20 percent of the raise. In the second, a 50-year-old should save 50 percent of the raise. And for the third, if a worker’s take-home has increased by $1,000, that worker should save $333 of the new income.

Those are just starting points, the report adds, but they can provide a framework that encourages employees to postpone instant gratification in favor of retirement savings.

Incidentally, the most effective of the three strategies is spending twice your years to retirement. The other two are better than the status quo but are good only up to the point where income outdistances savings again.

Since this topic isn’t often covered in retirement savings materials, workers need a bit more guidance on how much more they need to save with each raise to stay on track for retirement.

From: BenefitsPro