1 Thing Threatening Your Retirement Security
Written by
Jordan Rosenfeld
Edited by
Molly Sullivan
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Many workers believe they’re doing the responsible thing for retirement by consistently contributing to their 401(k) plans each year. But financial advisors say one quiet habit is undermining retirement security for millions of Americans.
Find out if you’re making this mistake, too.
The Retirement Mistake That Feels Responsible but Isn’t Enough
The big retirement mistake many people make is not increasing your contribution each year, the experts warned. The problem with “just” contributing even a regular amount to your 401(k) each year is that you’re missing out on exponential growth if you aren’t increasing that amount, according to Daniel Hancock, a chartered retirement planning counselor and CEO of Asset Financial Planners.
“We see ‘consistent’ savers get stuck on autopilot all the time. They think they’re safe because they haven’t stopped contributing, but they’re actually losing ground to inflation and lifestyle creep,” he said.
While many people start by contributing up to the employer match for their 401(k), they don’t consider changes to their lifestyle expenses and goals over time, said Phil Hayduk, a chartered financial consultant and financial advisor at Equitable Advisors. “Annual revaluations are necessary to stay on track to meet your retirement goals.”
Why Flat Contributions Shrink Your Future Buying Power
You can think of inflation as a kind of “hidden tax” on “flat savers,” Hancock said. Hayduk added, “If a person’s contributions remain the same, they’re effectively decreasing their 401(k) account value relative to future costs of living.”
When you maintain your savings ratio unchanged and your salary grows at a rate of 3% to 4% every year, “you are actually decreasing your buying capacity in the future,” added Chad Silver, a tax attorney, CEO and founder of Silver Tax Group.
And Don’t Forget About Lifestyle Creep
As incomes rise, so do expenses, a problem known as lifestyle creep. “The new truck, the bigger property or the travel budget absorb every new dollar of a raise,” Hancock said.
Thus, the worst mistake that a worker can commit is following a fixed sum of money and not a percentage, Silver warned. “Not incrementing the level of savings is an option of accepting a lesser standard of living in the future.”
The ‘On-Track’ Illusion and Status Quo Bias
One of the most common behavioral traps pre-retirees fall into is assuming they are on track simply because they started saving early and never stopped. This is what Hancock called the “‘I’m doing enough’ bias.”
“They set their contribution at 6% or 10% a decade ago and feel a sense of moral victory because they never stopped.”
However, if you do this, don’t feel bad — it’s common, Hayduk said. There’s a natural tendency for people to stick with their current financial plan, even when an adjustment could be more beneficial. Now that you know, you can change it.
Why Small Annual Increases Beat Catch-Up Contributions
Many workers assume they can fix under-saving later by maxing out contributions or relying on catch-up limits. However, Hancock said that small annual increases, even just 1%, are mathematically superior to waiting until age 50 to start catch-up contributions. “You can’t make up for 20 years of lost compounding in the final 10 years of your career.”
Small annual increases to 401(k) savings will have less of an effect on your cash flow and lifestyle costs than making a major change down the road, as well, Hayduk pointed out.
And while it’s important to take advantage of catch-up contributions, it’s not comparable to having increased your rate all along. “The use of catch-up limits is a losing game since you will not be able to compensate on 20 years of lost growth in one decade,” Silver said.
The Long-Term Cost of Not Adjusting Contributions
Over decades, failing to raise contribution rates can ripple into other areas of financial stress, including taxes, liquidity and retirement lifestyle constraints.
“If you aren’t increasing your contribution rate, you are effectively accepting a standard-of-living pay cut in retirement,” Hancock said.
Silver recommended people think of their 401(k) “as a dynamic cover against future liability and economic changes.”
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