My 6% Mistake: When You've Saved Too Little for Retirement

I thought I was doing the right thing. In my early 20s, when I barely made enough from my measly salary to buy lunch, I signed up for the 401(k) plan. My employer matched 50% of my contributions up to 6% a year, and all the personal finance gurus of the day whose books I consulted—I’m looking at you, Jane Bryant Quinn—exhorted me to max the match.

Do not turn down free money! they said.

So I sucked it up and elected to contribute 6% of my salary for that plan and all subsequent ones and I forgot all about my savings rate. After all, I was starting early and investing aggressively—wasn’t I being prudent?

Two decades later, I now have more years of saving behind me than I do in front of me. It’s halftime at the retirement bowl, and the home team is down. For as it turns out, that 6% wasn’t nearly enough. In his new book, The Truth About Retirement Plans and IRAs, Ric Edelman recommends contributing at least 10 percent. And in his recent manifesto for Millennials, If You Can, William J. Bernstein says that if you start saving at age 25 and hope to retire at 65, you will need to put away 15% of your salary. That’s almost three times the amount that my cohorts were advised to save as twentysomethings in the 1990s. So even though I avoided some other major mistakes, such as selling out of equities after market crashes, or picking funds with loads, my basic starting point, I’m just now finding out, was apparently way off.

How did I not realize this earlier? As my retirement funds crossed the six-figure mark, I likely fell prey to the illusion of wealth. The lump sum seemed much larger than its equivalent monthly income stream, giving me a false sense of security. This phenomenon, well-documented by behavioral economists, is a good argument for why plans should not just automatically enroll participants but also automatically increase contributions, a feature known as “auto-escalation.” According to a recent article by Anderson School of Management professor Shlomo Benartzi in Pensions and Investments, overcoming inertia to open a retirement account is just the first step. What’s missing in most plans, including Obama’s MyRA proposal, is a mechanism to overcome the inertia of not increasing your contribution. The tendency to stick with your initial savings rate is compounded, says Benartzi, by “the fact that the default settings are often seen as implicit endorsements.”

I can’t correct my 6% mistake, and there's no single way to make up for the shortfall. I can maximize my current 401(k) contribution, but only up to this year's deferral limit of $17,500. When I turn 50, I will be allowed to contribute a catch-up amount, currently $5,500. (“You don’t need to be “behind” in your plan contributions in order to be eligible to make these additional elective deferrals,” the IRS kindly clarifies.) I can open a non-deductible IRA, although they require annual tax reporting and Ric Edelman says “they’re not worth the hassle.” I have a Roth IRA that I converted from a former 401(k) but the earning limit makes me ineligible. And I also have a SEP-IRA that I opened when I was writing a book, which may be my best bet. But after a quick spin through IRS Publication 560, I still can’t figure out whether non-freelance income is eligible and whether you can contribute to an employer's 401(k) plan at the same time. Stay tuned for answers.

In retrospect, I don’t know if I would have been able to contribute more than 6% back in my 20s—I was making so little at the time that every dollar was precious. But by my 30s I would certainly have had the income and discipline to get to 10%, especially if I knew that 15% was optimal. I’m all for setting high bars, even if you fall slightly short. I just wish that they hadn’t moved the goalposts so far into the game.

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Ruth Davis Konigsberg, a fortysomething journalist and consultant to Arden Asset Management, writes weekly about retirement planning.