How to Supercharge Your Retirement Savings
You know you need to save as much as possible for retirement, but making the decision to put more money aside can be challenging. We all face so many competing priorities financially – how can you justify reducing your income today for a goal that could be years or even decades in the future?
But there is a solution: don’t reduce your income. Save your raise.
What to do
While you might not get a raise every year, generally speaking our incomes tend to rise over our careers. You can harness the power of that rising income level for the good of your retirement by choosing to save some or all of your raise.
For example, if you’re currently earning $50,000 a year and you get a 5% raise, your income will be $52,500 next year. Instead of taking that income, add it to whatever you’re already putting towards retirement.
That’s it: no loss of current income, no change in lifestyle. Just taking money you’re not used to having anyway and putting it towards a very important cause.
How it works
This might feel like an insignificantly small amount, and in many ways it is: divided over 12 months, a $2,500 raise might not have a major impact on your everyday quality of life.
But put that money aside and let it grow – and, most importantly, do that every time your income goes up – and you could see a significant snowball effect over the years.
Just imagine you get a 5% raise every 2 years over the next 5 years.
Look at the effect this would have on your retirement savings rate, assuming you started out not saving at all and saved the entire raise each time:
||5% raise, added to savings
||Total annual contribution
(Charts shown are for illustrative purposes only)
Without ever sacrificing your baseline income level, you’ve raised your annual retirement savings contributions from $0 to almost $8,000.
Why it works
The lack of sacrifice is important: as most of us have probably experienced, it’s a lot easier to see our incomes go up than it is to watch them fall.
Psychologically speaking, even if you know that setting aside more money is the right thing to do, it can be difficult to follow through if that means you have less money today.
Think about how your inner voice might ponder the idea of sending $8,000 to savings instead of using it as you currently do. Who really wants to reduce their income by that amount? What if you really need the money? Maybe it’s easier to just wait and do it later.
Saving your raise cuts straight through that thought process: after all, you don’t need the money because you didn’t have it anyway, so you never have to feel the pain of losing it.
Indeed, a study on an automated version of this savings scheme found that it was a highly palatable way to save more, and that people tended to stick with it over time.1 The study found that the average savings rate for participants went from 3.5% per year to 13.6% over 40 months.
That’s a powerful change.
The researchers, at UCLA and the University of Chicago, concluded that committing to future savings rate increases without sacrificing current lifestyle helped people overcome a lot of the psychological barriers to saving more.
But even if you don’t have access to a program that automatically puts your raise towards your savings, you can capitalize on their findings in the same way.
Make it happen
The important thing is to commit as early as possible. As soon as you find out about a future raise, put the necessary paperwork in to increase your retirement contribution at the same time.
Then, just go on with your usual life. After all, nothing’s changed!
Even if you don’t put your entire raise towards your retirement account, raising your contribution alongside your salary is a huge step in the right direction. If you continue to save income increases in the same way, you’ll see the effects over time.
And you’ll almost certainly thank yourself for it in the future.