Work v. Save Options Quantified
One of Americans’ biggest financial challenges is proper planning to ensure that their standard of living doesn’t drop after they retire and the regular paychecks stop.
A new study has practical implications for baby boomers in urgent need of improving their retirement finances: working a few additional years carries a lot more financial punch than a last-ditch effort to save some extra money in a 401(k).
This point is made dramatically in a simple example in the study: if a head of household who is 10 years away from retiring increases his 401(k) contributions from 6 percent to 7 percent of pay (with a 3 percent employer match) for the next decade, he would get no more benefit than if he instead had decided to work just one additional month before retiring.
Of course, this estimate should be taken only as illustrative. To get their retirement finances into shape, many people should plan to work several more years than is typical today. Baby boomers tend to leave the labor force in their early- to mid-60s, even though more than four out of 10 boomers are on a path to a lower retirement standard of living.
The strategy of saving just a little more works better for younger workers, according to researchers Gila Bronshtein at Cornerstone Research, Jason Scott at Financial Engines, John Shoven at Stanford University, and Sita Slavov at George Mason University. For the same 1-point increase in the savings rate, a 36-year-old gets nearly four times more benefit than a 56-year-old, because the 401(k) contributions will be made over several decades and will earn investment returns.
The main reason that working longer is so effective is that Social Security is retirees’ largest income source. Each year of delaying retirement increases the monthly benefit substantially – for example, signing up at age 70, rather than 62, increases it by about 76 percent. Other benefits to retiring later include more time for a 401(k) to grow through investment earnings and fewer years of retirement to pay for.
For the workers who are on the verge of retiring, it’s clear that saving more money is always helpful. But the best option is to try to keep working.
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