Can You Catch Up on Retirement Savings?

Key Points

  • The most important factor in determining whether or not you meet your financial goals is how much you save.
  • Even if you didn't start saving for retirement at an early age, you can still catch up—it's harder, but it's still doable.
  • Stop just thinking of saving. Start now!

Imagine this: You're 25 years old and just getting your career going, but you can't get into the saving and investing mode because you're not paid all that much to begin with and you have so many expenses. Normally, you wouldn't worry too much about it.

But, frankly, you're starting to get a little concerned. You keep hearing and reading over and over again about how you need to save for retirement because companies don't offer pensions anymore and, while the federal government is happy to take FICA taxes out of your paycheck each week, you can't depend on Social Security to be there when it's time for you to collect.

Sound like anyone you know?

Let's get the bad news out of the way real quick. We believe that the most important factor in determining whether you reach your financial goals is your level of savings. Just like your mother was right when she relentlessly hounded you about eating your vegetables, those who tell you to save, save and save some more are right, as well.

The good news is that a failure to demonstrate sufficient thriftiness right from the get-go can be overcome as long as you deal with the issue in its early stages. It's sort of like a cholesterol-laden diet—deal with it early in life and you'll be fine. Ignore it for years and years, and you could start to have some real problems.

Chris: saving from the start

Meet our prototype young go-getter. Chris gets out of college at age 22, takes a few years to get settled and at age 25 gets a job paying $40,000 a year. Chris gets annual raises of 3% and a promotion every five years that comes with a 10% raise. Chris is a diligent saver, putting away 10% per year of pretax income until retirement at age 65. By then, Chris has accumulated a portfolio of $1.3 million, assuming an annual return on the investments of 6%. That $1.3 million is worth $477,000 in today's dollars.1

Chris' situation may be even better with a working spouse, because that means more income for savings. We've also assumed no Social Security and no home equity, an important source of wealth for many Americans.

Robin: catching up

Based on my experience, there aren't too many people like Chris floating about, saving 10% right out of the gate. Is there no hope for those who didn't start saving early?

There is hope. Let's turn to Robin, who's identical to Chris in many ways: same pay, same raises, same promotions, same investment strategy, no housing wealth, no spouse, no Social Security. However, Robin doesn't start saving at the 10% level until age 30. For Robin to catch up to Chris, an 11.75% savings rate is required1. Tougher? Yes, but very doable, all things considered.

What if Robin delays even longer? For a reality check, take a look at the chart below. It shows what Robin's annual savings rate needs to be in order to catch up to Chris, depending on the age at which Robin begins saving.

The price of procrastination

Graph: The Price of Procrastination

Source: Schwab Center for Financial Research.

The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. Assumes 6% annual rate of return with reinvestments of dividends, interest, and capital gains. 

Looking at this graph crystallized something for me. There's a perverse logic in delaying the start of savings. The time to retirement is so long, there really is the possibility of catching up without lots of pain, at least for a while.

But that's why procrastination is so lethal. The benefits of not saving are immediate and obvious, and plays to our natural desire for instant gratification. Unfortunately, as the slope of the graph shows, the longer you wait, the harder it is to catch up—until it becomes essentially impossible.

In other words, procrastination lulls you into a sense of complacency. By the time you snap out of it, it may be too late.

So what should Chris and Robin do? The table below has our practical suggestions for each.

How to harness the power of savings
Suggestions for Chris Suggestions for Robin
Don't backslide. You're on the right track. Stop just thinking about saving. Begin now!
Up your savings rate 1% with each raise. Try to max out your 401(k) contributions.
Be an investor. Go beyond just saving in low-interest checking/savings accounts. Use an automatic investment plan (AIP) or automatic payroll deposit feature.
Invest in yourself and boost your earning power. Review expenses periodically. You need to know where your money's going.
Stay insured. Medical costs can derail your savings goals. Don't carry a credit card balance.

 

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Important Disclosures