Millennials are harnessing their best retirement weapon

Millennials now the largest living generation
Millennials now the largest living generation

Personally, I've had enough of people complaining about Millennials and our awful job, money management, and social skills.

While I can't speak to the job and social components, it turns out we've done something much better than our parents: We're saving earlier.

According to the Natixis 2016 Retirement Plan Participant Study, the average Millennial with access to a defined contribution plan (most commonly a 401(k)) began saving in a retirement plan at the age of 23. That's compared to age 27 for Generation X and 31(!) for Baby Boomers.

The benefits of those extra years cannot easily be overstated.

Let's take an example: John is 23, makes $50,000 a year, and defers 5% of his salary into his 401(k). Assuming he plans to retire at 65 -- 42 years later -- and that the market returns 7% annually -- which is a reasonable assumption given historical trends -- then he'll retire with $597,620. That assumes, by the way, that he never sees a pay raise (which is unlikely) and never increases his deferral (which is also unlikely -- as people age, they tend to devote a higher percentage of savings toward retirement income).

To highlight how important time is, let's imagine he started at 27, instead -- the average age a Gen Xer started saving for retirement. He'd only have missed out on deferring $10,000 ($2,500 per year), but the damage to his retirement would have been substantial. Losing those four years would leave him with only $446,875 at the age of 65. And if he'd waited until 31, as the average Baby Boomer did, he'd have only $332,147.

As you can see, time is the best retirement weapon Millennials have. And we're using it.

Unfortunately...

Even though we're saving early, we generally aren't saving enough. A whopping 66% of Millennials surveyed by Natixis were contributing between 1% and 4.99% of their salaries to their company's retirement plan. That number needs to be closer to 10%, which only around 9% of Millennials are currently saving.

Most retirement planners assume that people need to save between 10% and 15% of their salaries in retirement funds to retire comfortably.

Now, averages and typical numbers are inherently flawed because you are probably not average or typical, but let's work some numbers to give you a starting point from which you can think about what makes sense for your particular situation.

Let's say Joe (from the example above) defers 10% of his $50,000 annual salary into his 401(k) starting at age 23. That gives him a $1.1 million nest egg at 65, in theory.

And given that the average Millennial surveyed by Natixis thinks they'll need $869,662, it's reasonable to think that the example I gave above would comfortably overshoot the goal.

More complex

Unfortunately, it's more complex than those numbers imply. Here are five situations that would dramatically impact how much someone needs to save -- and render that $869,662 number too small for what someone's actual retirement needs might be. (Let's leave aside the question of whether $869,662 is the right number and assume that it does, in fact, represent the retirement needs of the average Millennial.)

1. What if inflation increases significantly at some point in the next 40 years? Suddenly purchasing power is down and the $869,662 in expected purchasing power is not enough. Instead, Joe likely requires something a lot more closely resembling the $1.1 million he would have saved by deferring 10% of his salary consistently.

2. What if there's a big market correction in the last couple of years before you retire? A 10% or 15% decline in your portfolio would make a big difference in how much you actually have at 65 -- so "over saving" early gives you more flexibility. A million-dollar portfolio that suffers a 10% loss a year before retirement leaves Joe (or you) with $900,000 -- still more than $869,662.

3. What if you develop a chronic illness? It could be diabetes, an autoimmune disease, or dementia. Fidelity pegs the average healthcare costs during retirement for a healthy couple at around $260,000. Developing a chronic disease could significantly increase the cost of healthcare beyond the $260,000 average. Better to have over-saved and be able to absorb some additional financial shocks.

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When saving for retirement, the most important thing you can give yourself is a big margin of safety because sudden financial shocks are just part of the deal. And, if you're way ahead of potential issues with an extra-large nest egg, you'll be in much better shape. Take the gift of time and double-down on it by adding to your retirement deferrals today.

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