Your increase could be a threat to your retirement

28 Aug 2020

I​​​​t is a known fact that the more you earn the more you spend. 

Most employees have two goals in their jobs. To make more money and to save for retirement. Making more money is quite easy through annual increases, promotions and bonuses. Saving for retirement is not so simple. 

There seems to be an unwritten rule that when we get an increase, we up our lifestyle. According to a recent study by financial firm Morningstar, this could damage your retirement plans. As we climb the corporate ladder, our lifestyle expectations change. For example, bigger cars, bigger houses and more expensive holidays etc. We spend more on our lifestyle, but the percentage we save for retirement doesn’t increase.

If you earn $60,000 a year and save 10% for retirement, that’s $6,000, and then if you get an increase to $80,000, you save $8,000. ‘My retirement savings are increasing right and it will be fine,’ you might say. It looks all rainbows on the surface.

This increase is great for inflation, but it doesn’t add up to your constant lifestyle upgrade that becomes more and more expensive. Without increasing the percentage of your retirement contributions, you won’t have enough at retirement to support your new upgraded lifestyle. This phenomenon is called lifestyle creep.

“Part of the reason the raise can hurt your ability to retire, if you don’t prevent lifestyle creep, is that your retirement savings grow slower than the raise. If you keep a constant 11% savings rate, as your salary moves from $100,000 to $120,000 at age 47, then your standard of living rises while your income from Social Security benefits and past savings remains relatively static.”

The graph below shows the results of a study done on the shortage of retirement savings on your new normal lifestyle after a salary increase. It shows a gap in retirement expectation when you retire.


So, what is the solution?

The study brought three different solutions to the table.

•    Spend twice your age of your increase – this means years to retirement. So, if you have 10 years left to retirement, spend 20% and save the other 80% towards retirement.
•    Save your age – if you are 40, you will save 40% of your increase towards retirement.
•    Save 33% of your increase towards retirement regardless of your age.

These are all viable options, but it was found that the strategies started to become less effective the older you got, and the best option was ‘spend twice your age’. It leaves you money to spend now, and you are bolstering your retirement fund.

How to avoid lifestyle creep?

•    Keep your expenses down and try not to fall into the upgrade trap, this way your retirement savings can keep up.
•    Saving more now lowers the gap between your current lifestyle and your retirement lifestyle.
•    Plan and budget for your raise before it is in your account. This way you can invest the required amount when you get your raise as opposed to trying to save once you are used to the extra income. *

Your deVere adviser could help you work out a new viable budget for your increase so that you can maintain a certain lifestyle in retirement. [email protected]

Please note, the above is for education purposes only and does not constitute advice. You should always contact your deVere adviser for a personal consultation.

* No liability can be accepted for any actions taken or refrained from being taken, as a result of reading the above