By Sam Harris
Data from the St. Louis Federal Reserve Bank in recent months indicates that the personal saving rate in the U.S. is at a 50-year low. Americans are setting aside a paltry 3 percent of disposable income. From the 1960s to the early 1980s this rate routinely hovered around 10 percent. Since then, however, we’ve seen a slow and steady drop to today’s levels. There was an uptick following the sobering events of the Great Recession, but our memories have faded as we’ve quickly regressed to pre-Great Recession levels (see chart below).
When I was a kid, a popular expression was “pay yourself first.” What this expression means is that one should continually set aside a part of each paycheck in a savings account to cover unforeseen events and retirement. Apparently, this message was not as common as I had thought or, perhaps, very few of us listened. The “pay yourself first” message is being overshadowed by the modern rallying cry of YOLO (“you only live once”). Planning-for-tomorrow is being replaced by living-for-today–to the tune of spending 97 percent of each paycheck (and growing!).
Part of the problem may relate to the lack of “real” (i.e., inflation-adjusted) income growth in the U.S. A dollar doesn’t stretch as far as it used to in regard to items such as housing, education and medical costs. However, some other costs have become substantially less expensive, including food, cars and technology. You don’t have to look far to see all of our “discretionary” purchasing. Starbucks is an $80 billion dollar company. Need I say more? And, let’s not forget our friends at Verizon, Netflix and Amazon. It’s scary to think of how many people readily sign up for automatic monthly plans to spend money, but how few set up similar plans to save it.
I fully support having fun and maintaining a healthy work-life balance, but we’re living longer these days and need to plan for the future. On average, people born today can expect to live 79 years and they’re going to need a “rainy-day” fund many times during those years, including a big chunk for retirement income.
As we’ve all heard, we can’t expect Uncle Sam to bail us out. The major social welfare plans–Social Security and Medicare—appear to be headed for financial challenges given the size of the current workforce relative to retiring “baby boomers.” Moreover, our national debt is at an all-time high and we’re running an annual budget deficit that is expected to exceed $1 trillion dollars per-year through 2020. There isn’t likely to be extra cash lying around to cover the predicted shortfalls in Social Security and Medicare, let alone increase them.
Folks, we can do better! The key is to get started or, for those already saving, crank it up a bit. Two of the best options for saving money for the future are 401K plans and Traditional IRAs. 401K plans are set up by employers to facilitate retirement savings by employees. They have the same features as IRAs (discussed below), and often employers are willing to match your contribution, up to a certain level. That’s free money–you should take it!
Another great option is a Traditional IRA (Individual Retirement Account). Banks and brokerages make it easy to set up IRA accounts and money can even be automatically contributed from your bank account each month. IRAs have many desirable features including the following:
Contributions are tax-deductible. Subject to certain income limitations, IRA contributions can be deducted from personal taxable income. Saving money is not just a smart thing to do, you can get paid by the government to do it. Don’t leave this free money on the table.
Earnings are tax-deferred. All appreciation in your IRA, whether in the form of capital gains, dividends or interest, are free from taxation until you begin to withdraw funds in retirement.
“What about the pre-retirement “rainy day” scenario?” you ask. These options look great for saving for retirement, but what if you need money before then? Many 401Ks provide the option of borrowing money from the plan itself. That’s right, often you can borrow money from your own pool of capital and pay interest to yourself. Moreover, when/if you leave your employer, there are generally withdrawal options at that time or, at a minimum, you can convert the vested portion your 401K into an IRA account.
IRAs also provide flexibility in regard to early withdrawals. Funds can be withdrawn at any time by paying a 10 percent penalty on the withdrawal. But let’s look at options for avoiding that penalty. Keep in mind that the IRA funds may be withdrawn, penalty free, beginning at age 59½. The government also provides certain situations where you can withdraw money before 59½ and avoid a penalty. For example, you may withdraw money early for certain educational expenses, medical expenses, first home purchases or if you become disabled. The IRS web site provides a detailed description of how to qualify for each scenario.
There is also another type of IRA called a “Roth IRA” that may be an attractive option. Roth IRA contributions are made with “after-tax” money but, like Traditional IRAs, grow tax-free until retirement. Roth’s also have a few added benefits related to early withdrawals and withdrawals in retirement. Lastly, if you have a business there are numerous other savings options that can be utilized with substantial tax benefits.
Now start saving!
*If you’d like to see the past 50 years of our saving rate, you can find it here: https://fred.stlouisfed.org/series/PSAVERT.