(This article appeared previously on Marketwatch.)
We tend to think of midlife workers as in their career prime. Folks in their 40s and 50s have plenty of professional responsibility to show for their decades in the workforce. And by his mid-50s, the median male worker is making about 127 percent more than he did when he was just starting out in his career, according to a report released this February by the Federal Reserve Bank of New York.
But what midlife workers don’t have, for the most part, is the sharp upward earnings arc that characterized their 20s and, to a lesser extent, their 30s. The fat raises that workers typically enjoy as they establish themselves in their careers give way to smaller bumps that just keep pace with inflation.
What the New York Fed Found
Pay peaks for males in the early-to-mid 50s then decline in the decade before retirement, in inflation-adjusted terms, the New York Fed analysis found. (That study focused on men, because women’s trajectories tend to be complicated by breaks from the paid workforce to care for children or aging parents.)
An analysis by PayScale of both genders found women’s pay growth stopped on average at age 39, in real terms, while men’s topped out at age 48. Physical laborers might peak even earlier as their bodies slow down, while on the other end of the spectrum, CEOs might see stratospheric gains in their 50s and 60s.
What midlife workers don’t have, for the most part, is the sharp upward earnings arc that characterized their 20s and 30s.
The typical earnings trajectory has serious implications for retirement savings. Young people accustomed to regular big raises may think they have plenty of time to make up for a savings shortfall after their kids are grown and out of the house. And yet, those catching up in their 50s are “doing it against a headwind of potentially declining earnings, which makes it much harder,” said Michael Kitces, partner and director of research at Pinnacle Advisory Group in Columbia, Md., who analyzed the Fed survey on his blog.
The Internal Revenue Service allows retirement savers ages 50 and over to contribute an additional $6,000 annually to their 401(k)s and an additional $1,000 annually to their Individual Retirement Account. Younger savers have a cap of $18,000 and $5,500, respectively.
Those whose adult children have become financially independent can sock away the money they used to spend on college tuition and other expenses. Yet those who don’t have children, or those still supporting their offspring, may have a harder time making catch-up contributions if their wages are stagnant or even worse, declining.
Without raises that exceed inflation, many midlife workers will have to cut something from their budgets to find that additional catch-up savings. And that’s easier said than done when people get used to a certain lifestyle. Those who have grown accustomed to a house cleaner are loath to resume mopping their own floors, just as those who buy new cars don’t want to trade in that new-car smell for used. “It’s so hard to go backwards,” Kitces said.
Fighting Lifestyle Creep
Since it’s hard to rein in a lifestyle that you’ve enjoyed for decades, a better strategy is to keep that lifestyle in check from the get-go. In other words, don’t let your expenses grow in tandem with your raises.
Kitces calls this fighting “lifestyle creep.” The first time most people buy a new car, they’re not just plunking down $25,000-plus on a single vehicle, Kitces said. Instead, they’re in effect locking in the extra $250,000 or so that they’ll spend on new cars for the rest of their lives, since they’re not going to go back to used. “You just need a car to get from point A to point B,” said Kitces, who drives a nine-year-old KIA Spectra that he bought used, with cash, after trading in another old KIA. “You don’t need a new automobile every three years.”
Another good way to fight lifestyle creep is to spend just 50 percent of every raise and systematically save the rest, Kitces said. When we automate our 401(k) savings at a fixed percentage of our pay — say, 10 percent — and we get a raise without adjusting our savings level, then we implicitly train ourselves to spend 90 percent of that raise, Kitces said.
The 127 percent earnings growth that the median male experiences from age 25 to 55 equates to a real growth rate, above inflation, of almost 3 percent per year, according to Kitces’ analysis of the New York Fed report. But in real life, this growth isn’t steady; it’s front-loaded at the beginning of workers’ careers, so folks who establish an early habit of saving half of their raises will pocket a more meaningful amount than they will later in their careers, when their raises are just keeping pace with inflation.
Serial entrepreneur and blogger Penelope Trunk has applied the lessons of earnings arcs to real estate. People tend to purchase their first home in their early 30s, with a fresh history of big raises behind them. Assuming people qualify for a mortgage, it’d be tempting to buy a home that’s a bit of a stretch financially, anticipating another a fat raise to make up the difference. Instead, Trunk writes, “you should buy a house preparing for your real income to remain unchanged until age 55, when it is likely to go down.”
Making Up for Lost Time
This doesn’t mean that workers who hit their 50s with a retirement savings shortfall should just throw up their hands and resign themselves to subsisting on Social Security. That’s a risky strategy: a 55-year old couple retiring in 10 years will need about 90 percent of their lifetime Social Security benefit just to cover healthcare expenses, according to a report this March by HealthView Services, a Danvers, Mass.-based provider of health-care cost data and planning tools.
Those who reach midlife without much of a nest egg are going to have to sock away more than the standard 10 percent to 15 percent of their pay to catch up. But you don’t have to get to that level right away, said Michael Pellegrino, principal of Goldstone Financial Group in Oakbrook Terrace, Il. Many people aren’t going to be able to stomach the abrupt change from saving nothing to saving some 20 percent of their salary.
Instead, if you start with 2 percent or 3 percent and see your account balance gradually grow, then “it’s a motivating factor, and you might decide to skip your daily coffee and bring it up to 5 percent” and then up from there, Pellegrino said.
It’s not easy to dial back lifestyle choices, but it’s definitely doable. Cleaning may be drudgery to some, but it’s also exercise. Ditch the regular cleaning service and you may also decide to ditch the pricey gym membership. Savings begets savings — think of it as lifestyle creep in reverse.
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