Are You Saving More as You Earn More?

Are your lifestyle choices today short-circuiting your retirement plans?

As you receive annual pay increases and promotions, you should be saving more for your retirement. Your pay raises though may “actually make it harder to achieve a comfortable retirement,” according to a 2020 article, Controlling Lifestyle Creep: How to Advise Clients When They Get a Raise by the investment firm, Morningstar.

A bigger paycheck empowers people to reward themselves. Many times, our expenses grow at the cost of retirement savings not keeping up with the same proportion of our income.

John Maynard Keynes’ General Theory published in 1936 suggested that the personal saving-income ratio was consistently determined by one’s income and would almost increase as much as income increased. Franco Modigliani was awarded the Nobel Prize in 1985 for challenging Keynes’ work. Modigliani believed the amount of savings one would save for retirement would reflect their view on their lifetime resources.

People, according to Modigliani’s research, ideally will attempt to calculate the required assets they should save to have a stable lifestyle in retirement. Modigliani’s hypothesis is called the life-cycle hypothesis (LCH).  

Two decades later, behavioral economists conducted research that revealed that people deviate from the LCH model. Savers in the study. Regretted earmarking current dollars for retirement because it meant a postponed indulgence. Procrastination and other factors sabotaged plans to increase retirement savings.

The economists, Richard Thaler and Shlomo Benartzi then created Save More Tomorrow, or SMarT, to address the retirement shortfalls in the real world. SMarT is a pension program designed to increase employees’ savings rates as they were promoted.

“The increase in pension contributions of the person joining the SMarT plan will happen when they get their next pay raise. This way, people will not experience a loss in pay, but rather a decrease in future gains. By avoiding feelings of loss, it becomes easier for people to accept increases in pension contributions. This feature also reduces the amount of self-control needed for the program, as people in the plan do not need to cut spending and thus avoid the experience of spending power decrease.”

In its 2020 online article, Morningstar offers three rules of thumb that you might want to consider to ensure you can save enough to have a stable retirement. These strategies are:

  • Spend twice your years on retirement. If you are going to retire in 10 years, you should spend 20% of your raise and save the remaining 80% for retirement.
  • Save your age, as a percentage of the raise. If you are 50 years old, you should save 50% of the raise.
  • Save at least 33% of your raise. If your take-home income increased by $1,000, you should save $333 of that new income.

The Federal Employee Retirement (FERS) and the U.S. military’s Blended Retirement System (BRS) currently do not offer something like the SMarT plan’s software to automatically increase contributions in the Thrift Savings Plan (TSP) when one is promoted or receives raises. 

FERS employees and members of the uniformed services should remember they have two choices to make regarding TSP contributions. These are percentages of salary or fixed dollar amounts. Also, if they have not yet attained their 50th birthday, they should ensure they receive matching contributions from the TSP thru the last pay period by keeping their overall contributions below the $20,500 elective deferral limit for 2023. 

Each year contributions will go up as your salary goes up when using the percentage of salary contribution choice for the TSP. However, if you are highly compensated, choosing a percentage of your salary may result in you reaching the elective deferral limit before the end of the year; thereby losing out on some matching contributions for the last weeks or months.

Fixed dollar amount contributions mean calculating your fixed dollar amount each year to ensure that your contributions take you up to the limit but no further. For example, an individual could have equal contributions over the course of the 2023 calendar year (for 26 pay periods) or $866 per pay period. 

Saving for your retirement in the TSP also offers you the opportunity to explore having your contributions distributed between the Traditional or the Roth alternatives. You may want to consider the advantages of tax-free income sooner rather than later because you will have to have Roth TSP established five years before you access them, and you will have to be age 59 and a half to do so. 

About the Author

Francis Xavier (FX) Bergmeister retired from the USMC and the F.B.I. Consider following him on LinkedIn as he shares articles from others about retirement and other financial topics. He also provides retirement seminars thru Federal Career Experts.