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The Problem With Saving 10% of Your Paycheck

By Dayana Yochim - Updated Apr 6, 2017 at 1:36PM

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Follow this rule of thumb ... if you never want to afford retirement.

"Save 10% of your paycheck." This money chestnut handed down through the ages gives the impression to those who follow it that they'll be just fine by the time they retire. Too bad it's not true.

What's missing from the 10% rule of thumb is this vital footnote: "... As long as you start by age 25 and never stop saving 10% of every dollar you earn until age 65."

But that's not what most of us do. Instead, we buy our homes and cars and put the kids through school, and then -- after a few vacations, home renovations, and transmission overhauls -- we finally get serious about saving for the future.

And what does that leave us with in retirement? Not nearly enough.

Who's really picking up retirees' tabs?
Every year, the Employee Benefits Research Institute (EBRI) asks workers what they expect will be the major sources of their retirement income. Then EBRI then compares their expectations to the actual experience of current retirees.

Our willingness to pay for our own futures is admirable: In the 2009 survey, the majority of workers (60% to 75%) indicate that they expect to cover the bulk of their retirement expenses from their own savings (including employer-sponsored retirement savings plans, IRAs and other personal investments). And 81% indicate that Social Security will cover some part of their expenses, too.

You might not want to be too quick to reach for the tab: 92% of retirees report that Social Security is the major source of their income. And how much do they rely on personal savings to pay their expenses? Less than half say that money they socked away (in 401(k)s, IRAS or other investments) helps them pay the bills. And 58% rely on income from a pension.

So the question then becomes, how confident are you that Social Security will be around to support you during your dotage? And what about income from a pension? Do you even know of any employers in your field that offer pension plans anymore?

That brings us back to that 10% savings rule of thumb.

So how much should you really save?
We all know we should be saving more ... but less than half of us (46%) have even tried to figure out how much we'll really need by the time we retire, according to EBRI.

If you're a savings late-bloomer, you might want to brace yourself before this next paragraph. Ready?

A study in the Journal of Financial Planning revealed that a 45-year-old will have to sock away twice as much as a 25-year-old to enjoy the same lifestyle in retirement. Wait until age 55, and you're looking at some major belt-tightening -- saving three times as much per paycheck as the young whippersnapper in the next cubicle. Oof.

Four ways to be a smarter saver
You don't have to scale back to ramen noodles and take in renters to turn your future around. Remember, the amount you save is just one part of the equation. Yes, you should save more. But saving smarter is even better. Here are three strategies that'll help you play catch-up quickly.

1. Milk your workplace for every cent you can
Contributing to employer-sponsored 401(k) and 403(b) plans with matching offers an instant savings boost. A 25% match (the equivalent of two-year market-beating returns just for showing up) turns a $5,000 contribution into $6,250. If you're 50 or older, take advantage of yet another break -- a tax break -- via the catch-up contingency, which lets you sock away as much as $22,000 in pre-tax dollars.

But even if your employer doesn't offer a match, remember, your contributions to a 401(k) (or a traditional IRA) lower your taxable income. So you pay less in taxes now, and the money you sock away grows tax-free until it's time to start using it to cover retirement expenses.

2. Get paid by Mr. Market
We know it's been a bumpy ride. But if you're decades away from retirement, the stock market is the best place for your savings. The same holds true even if your retirement party is next week. Don't quit the stock market once you hang up your suit and tie. Give the money you don't need in the next five to 10 years room to run without risking it all on highfliers.

Consider this oft-overlooked footnote about the stock market's historical 10% annual return: 6% comes from capital appreciation, and 4% from gains from dividends. Late savers can improve their lot with less risk with investments carrying above-average dividend yields. Many popular stocks, including Coca-Cola (NYSE: KO), PepsiCo (NYSE: PEP), and Procter & Gamble (NYSE: PG), have yields at or near 3%. Even stocks like General Electric (NYSE: GE), which cut its dividend last year, still yield more than 2%.

3. Make the most of all your assets
You can work in retirement, or you can make your assets do more of the heavy lifting. Annuities and reverse mortgages -- two strategies regularly covered by my colleague Robert Brokamp at the Motley Fool's Rule Your Retirement service -- can be lifesavers to cash-strapped retirees. But they are complex vehicles, best not entered into lightly.

4. If nothing else, come up with YOUR savings rule of thumb
Remember, the 10% savings myth is at best an oversimplified starting point (and, at worst, it could lead you to make some critical miscalculations about your long-term financial health). The best retirement gift you can give yourself is to see if your current savings strategy is roughly on track. Use the calculators in our Retirement Planning area to get rough estimate of how far your current savings will take you in your golden years.

If you need a second set of eyes and some personal guidance on customizing your retirement plan, the Garrett Planning Network -- a group of fee-only financial advisors (the only kind The Motley Fool recommends) -- is offering a limited-time, 10% discount for new Motley Fool clients. Use this map to search your state, and look for The Motley Fool icon to identify participating advisors.

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Stocks Mentioned

The Coca-Cola Company Stock Quote
The Coca-Cola Company
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General Electric Company Stock Quote
General Electric Company
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The Procter & Gamble Company Stock Quote
The Procter & Gamble Company
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