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Behind on Retirement Savings? It's Not Too Late to Catch Up

New research suggests parents can meet nest-egg goals with aggressive saving after the kids are out of the house.

The Wall Street Journal - 07/12/2018

When it comes to saving for retirement, conventional wisdom calls for starting early and saving 10% to 15% or so a year. But that can be difficult for parents who are spending on child-rearing while also saving for college.

For parents who have become retirement-savings laggards, recent research by Boston College's Center for Retirement Research suggests another route to building a nest egg. It finds that many fall behind on retirement savings during child-raising years. But while that's OK as long as there is a plan to catch up after the children leave home, few households save significantly more during their empty-nest years.

For many people, "the transition into the empty nest is the key moment for retirement savings," says Michael Kitces, director of wealth management at Pinnacle Advisory Group Inc. in Columbia, Md.

These latecomers in theory can not only dedicate a greater share of their income toward retirement savings, the thinking goes, but they also have less at risk if the market declines, in comparison with those who save early and rely more heavily on compounding for gains.

Of course, playing catch-up comes with risks of its own. If one or both spouses lose a job, a couple will have even fewer resources to get back on track. Plus, people who are used to spending most of their paychecks may find it difficult to get into the habit of saving.

Regardless, a catch-up strategy may be the most realistic way for many families to deal with the financial pressures of raising children. "The idea of saving a steady percentage of income throughout our working lives, when the expenses of raising children are anything but steady, has never been a reasonable approach," Mr. Kitces says.

Here's how to make the delayed-savings approach work:

Do the math

Several months before facing an empty nest, figure out how far behind you are on retirement savings.

Start by estimating the amount you want to spend in retirement. Many financial advisers assume retirees can get by on about 80% of what they earned while working. For a 50-year-old couple with a projected income at retirement age of $100,000, the annual goal would be $80,000.

The next step is to deduct from that $80,000 estimated Social Security and pension benefits. If a couple expects to receive $30,000 a year in Social Security at 65, for example, they would need savings to supply $50,000.

Multiply that number--$50,000 in this case--by 25, which represents the inverse of the "safe" 4% withdrawal rate that historically has given retirees a high probability of never running out of money. The result--$1.25 million--is the amount the couple would have to save to be able to withdraw $50,000 in the first year of retirement and adjust that spending annually to keep pace with inflation.

If the couple has already saved $280,000, they will need $970,000 more. To get there in 15 years with a 6% average annual investment return, they should save $25,000 per year in a 401(k) or individual retirement account, according to David Blanchett, head of retirement research at Morningstar Inc.

While a $25,000 savings goal may sound unrealistic, it is slightly less than the $26,000 the U.S. Department of Agriculture estimates families with incomes between $59,200 and $107,400 spent, on average, per year in 2015 to raise two children under the age of 18. (For families with higher incomes, the average annual per-child expenditure jumps to $20,000 or more.)

Make a plan

The problem, once you've come up with your number, is adjusting spending to hit your amplified savings goal. Households don't generally increase their saving much when kids leave home, according to a recent study by Boston College's Center for Retirement Research. Instead, the study adds, parents appear to take the opportunity to spend more on themselves. On average, after the departure of the last child, empty-nesters raise their saving in tax-deferred 401(k) accounts by slightly less than one percentage point of income. (They save an additional two percentage points due to accelerated mortgage repayments, which are a form of savings.)

To buck the trend and meet the aggressive savings goals required for the delayed approach, financial advisers suggest empty-nesters consider some personal-finance basics.

Use technology to rein in spending: Online programs such as Mint can show your past spending patterns and alert you when you are in danger of going over a budget.

Using tools or having a written budget is valuable because "most people really don't know what they spend. They just charge it," says Carol Hoffman, a financial planner in Blue Ash, Ohio.

To change habits, couples need to "train their brains" to think of spending cuts as positive, says Michaela Herlihy, a planner in Hyannis, Mass. "Don't tell yourself 'I am not allowed to go out to lunch anymore,'" she says, "Frame it as,"'I have committed to going out to lunch once a week to build up my savings for retirement.'"

Think about why you are spending: "Transitions can be tough," says Mark Struthers, an adviser in Chanhassen, Minn. "Some people use spending to occupy the time the kids used to."

Others continue to spend on adult children. Parents who do so should consider the consequences for their retirement savings and the need to instill in their children the skills to achieve financial independence, says Bill Parrott, an adviser in Austin, Texas.

Plan on smaller indulgences: On paper, it may make sense to bank all the money previously allocated to child-related expenses. But such a plan "ignores human nature," Mr. Struthers says.

Ms. Hoffman says many of her clients enter the empty-nest phase with many projects on their "to do" lists, including updating kitchens and bathrooms. The key, she says, is to budget a reasonable amount and understand you may need to delay retirement to afford it.

Make savings automatic: Once you have decided how much more you need to save, tell your employer or bank to automatically transfer the money to your 401(k), IRA or taxable brokerage account.

Pre-program such automated transfers months before you become an empty-nester. Ideally, you should designate the month after the last tuition payment is due as the time for the extra savings to kick in. That way, you won't see a larger balance in your account and face the temptation to spend it.

"Rather than assume it's too late to make a difference," people in the empty-nest phase should recognize that "now is the time to take action," Mr. Kitces says. "Don't think of yourself as behind." After all, he adds, many people with children are in the same situation and "by saving 20% to 30% or more of your income, it's possible to bridge a retirement savings gap pretty fast."

Copyright 2018 Dow Jones & Company, Inc. All Rights Reserved.

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The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.

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