Millennials, Rethink Your Approach To Retirement Planning

A seven-figure retirement savings account seems like pie in the sky to most 20-somethings, but financial experts say it’s possible.

There are two parts to becoming a millionaire, they say: time and diligent investing.

“The secret to the whole thing is the earlier you start, the better. Then compounding interest is working for you,” says Dean Hedeker, principal of Hedeker Wealth, a wealth management and financial planning firm in Lincolnshire, Illinois.

How much money a person can save will vary, of course, depending on salary, student debt and expenses. The good news for 2017 college graduates is that starting salaries are up across the board compared to 2016. The National Association of Colleges and Employers reports that average starting salaries for 2017 college graduates range from a high of $66,097 for engineering students to $48,733 for students with humanities degrees.

Katherine Schoen, manager of the private wealth management equity and fixed-income research team at Baird in Milwaukee, recommends that future millionaires take advantage of company matches in retirement accounts, like 401(k)s, when estimating how much to save.

She calculated savings rates for two hypothetical 22-year-olds – one making the average 2017 starting salary and one earning less. A 22-year-old making $30,000 a year and saving 8 percent annually will have $1 million for retirement by age 66.

“I was having a conversation with a co-worker – we’re on the high (end) of millennials – on what is realistic,” she says. “If you’re saving 5 percent and have a 3 percent match from your employer, that’s 8 percent in a retirement account and is doable.”

Schoen’s calculations assume a 3 percent inflation rate and a 3 percent annual salary increase, with an average return of 6.76 percent, the metric Baird uses to calculate returns over time for a mix of 80 percent equities and 20 percent bonds.

The numbers improve for someone earning $50,000, about the average 2017 starting salary.

“At $50,000, with just a 5 percent (total) savings rate, you could have a million in your account when you’re 65,” she says, using the same variables. “Or change it to 8 percent total, then at 67 you almost are at $1.8 million.”

Schoen says she understands the juggle millennials face – student loans, cost of living and other money suckers. Saving for retirement only adds to that financial burden.

“On paper it’s easy to see (saving is) worth it in the long run,” she says, but that requires thinking long term.

Waiting costs more. The longer a person waits, the more money it takes to reach the same goal. Hedeker says the person with 30 years to save needs to put away $900 a month to attain that same $1 million goal with a 7 percent return.

Schoen says someone starting out at $30,000 who earns, say, $40,000 at age 32 and waits until then to save would need to sock away 12 percent to have $1 million for retirement.

Nancy Doyle, author of “Manage Your Financial Life,” says given that young investors have limited funds, they should minimize investment fees, paying no more than 50 basis points. Those fees, she adds, should be factored into the total return.

Exchange-traded funds are one way to keep costs down. For example, a fund like the SPDR S&P 500 ETF (ticker: SPY), which tracks the Standard & Poor’s 500 index, has an expense ratio of 10 basis points.

Beware online retirement calculators that use optimistic return rate assumptions, she says. These can give people the idea they can save less because some calculators assume a return of 8 percent or more. To be safe, investors should use conservative rates of return – around 6.5 to 7 percent – when projecting far into the future.

Time to act. Inertia or a lack of urgency often hinder savings goals, says Jack Towarnicky, the Chicago-based executive director of Plan Sponsor Council of America, a retirement plan advocacy group. But since the 2006 Pension Protection Act, company retirement plans have been enrolling employees automatically, and savings rates have risen dramatically, especially for younger workers.

Of the employees who are automatically enrolled, “typically more than 80 percent remain in the plan and accept the default savings rate,” he says.

That default rate has been around 3 percent of pay, but some plans are pushing it closer to 6 percent. Once people get into the habit of saving, they have a good chance of becoming middle-class millionaires, Towarnicky says.

Many 401(k) or 403(b) plans offer target-date funds, making it easier for people who are unsure how to choose investments. Target-date funds adjust the risk level annually based on a retirement target date. Morningstar rates target-date funds from Vanguard and BlackRock the highest.

For anyone without access to a company work plan, Hedeker recommends opening a Roth individual retirement account, with investors in their 20s using a mix of 80 percent stocks and 20 percent bonds in the portfolio.

“If the goal is to get to $1 million, a diversified portfolio of stocks is how (to do it),” he says.

He prefers the Roth IRA because earnings grow tax-free, and the accounts have other benefits.

“In most states Roth IRAs are creditor-protected,” and depending on state law, you can file for bankruptcy and keep the Roth IRA, he says. Because Roth investors can withdraw the original contribution at any time with no penalty on that amount, “you’ve set it up so you’ve got maximum protection and total flexibility.”