In a recently released white paper, analysts suggest defined contribution (DC) plan participants may have to increase their savings rate to adjust for future market expectations in order to realize their target replacement income goal. For Millennials, that savings rate is 22%, according to research from NerdWallet.
A number of analysts predict that the slower growth of the U.S. economy after the Great Recession could cause stock market returns to fall from 7%, the current annual average, to a possible 5% in the decades to come, NerdWallet notes. The difference of two percentage points has big implications for younger adults who are just starting to save for retirement and also for those who’ve been investing for about a decade. Most retirement experts currently recommend saving 15% of annual income.
However, NerdWallet analyzed the saving needs of a 25-year-old earning $40,000, the median average salary for ages 25 to 29, according to the U.S. Census Bureau’s 2015 Current Population Survey. Based on the 7% average in stock market returns each year since 1950, a 25-year-old earning $40,000 can meet a common retirement goal of replacing 80% of his or her income by age 67 by saving 13% of annual income. But if average annual stock market returns fall to 5%, NerdWallet’s analysis shows a 25-year-old will have to set aside 22% of annual income to save the same amount. That’s an increase of $3,400 this year.
NerdWallet suggests Millennials start saving now. Its analysis found that if a 25-year-old Millennial waits until age 35 to begin saving for retirement, he or she must save a nearly impossible 34% of income annually, or $16,400, to retire at age 67 with an 80% replacement income, assuming 5% annual returns.
In addition, it is important to get Millennials to participate in employer-sponsored DC plans and to save enough to receive the full company match in the plans, NerdWallet says. It also suggests that Millennials should be discouraged from putting all their extra cash into a savings account. “Millennials may be focusing on building an emergency cushion, but they shouldn’t let that goal push saving for retirement down the road,” says Arielle O’Shea, NerdWallet’s investing and retirement specialist.
The study report may be found here.