Want to retire? More savings, not higher returns, will get you there

First, the good news: it is entirely within your power to make a significant difference in your retirement income security.  Now, the bad news: because it is within your power, you have to do the work. You cannot rely on the investment markets to carry you to a comfortable retirement. Your level of retirement savings—not the performance of your retirement investments—has the largest impact on how much you will have to live on when you retire.

Unfortunately, too many American workers are not going as far as they should in order to build a retirement nest egg. Although the use of employer-sponsored savings plans such as 401k accounts is high, two-thirds of workers have saved just $50,000 toward their retirement, found a survey by the Employee Benefit Research Institute. Meanwhile, the use of Individual Retirement Accounts has declined, with only 46% of Americans using them and only 7% are planning to open new IRAs before the April 16 deadline for 2006 contributions, found a survey by Fidelity Investments. It is no wonder that Social Security benefits and employer pensions are still the main sources of retirement income for many workers. About 20% rely on the sale of a primary residence to help cover retirement expenses, the survey also found.

Retirement savers can get too hung up on increasing their earnings rate. They hunt for the highest interest rate available on fixed income products, or allocate more to the stock market and spend time deciding on the right asset allocation. This is not something they should ignore, but it isn’t the key to building the biggest retirement fund possible.

Increasing your investment return by two percentage points a year will certainly result in a bigger nest egg, but increasing your savings rate by a similar amount will have a far greater impact. For instance, suppose you are saving $2,000 per year at 6%. You take on more investment risk and earn 8% per year. In 25 years, the higher risk will translate into $36,483 additional dollars (you earn a total of $109,729 at 6% and $146,212 at 8%).  However, suppose you stuck with the less risky 6% investment return but saved $4,000 per year. After 25 years you would end up with $219,458, which is $73,246 more than if you had adopted the riskier strategy but saved only $2,000 per month.

Now is the time to consider increasing your contributions to a retirement savings plan at work. Try increasing your contribution by 2% of your salary initially, and then add 1% more per year until you get to the maximum allowed. The 401k contribution limit this year is $15,500, and if you are 50 or older you can contribute $20,500 (high income employees may be limited to lower levels due to federal discrimination rules).

Also, consider a Roth IRA or a deductible IRA, if you qualify. The IRA limit this year is $4,000, with workers 50 and older able to contribute $5,000. The basic IRA contribution limit increases to $5,000 next year. Saving more at a younger age has the biggest impact, but even saving more at age 55 will have a positive impact on your net retirement wealth.