Executive Summary
Despite decades of encouragement to save a percentage of annual income, the national savings rate has been in decline for decades, and a disturbing number of today’s 50-somethings are seeing their children off to college, only to turn to their own financial situation and realize there's a significant shortfall in retirement preparedness.
Yet given the reality that it’s very expensive to raise children – including the ballooning cost of college – arguably this transition into the empty nest phase provides a unique opportunity for households to play “catch-up” for retirement… simply by taking the money that was once being spent on the kids, and saving it instead!
In other words, perhaps the idea of saving a steady percentage of income throughout our working years was never a reasonable approach to begin with, and that a strategy more sensitive to the spending realities of the child-rearing versus empty-nest phases of accumulation is both more realistic, and what many households will end out doing anyway.
Which means the real key to retirement success may not be about saving early and often for the long term at all, and that instead a significant post-child-rearing-phase "catch up" sprint is the normal path to retirement success. In turn, this suggests that the most crucial phase of retirement saving is not figuring out how to save during the early working years, and instead is about ensuring that the transition into the empty nest phase is used as an opportunity to catch up on retirement savings – after all, just 15 years of saving 30% of income once the kids are out of the house is still enough for an astonishing number of households to stay on track for retirement!
The Traditional Save-A-Percentage-Of-Income Approach To Retirement
The traditional approach to retirement saving is relatively straightforward: save a percentage of your income every year to put towards your retirement. The longer the time period, the more it can grow and compound. The higher the percentage you save, the faster you’ll reach your retirement goal.
For instance, if you’re 25 and make $50,000/year and save 10% of your income, get 3%/year raises (for inflation) along the way, and save in a long-term aggressive growth portfolio that gets an 8% long-term rate of return, by the time you retire you’ll have a whopping $2,000,000 retirement portfolio!
Of course, an important caveat is that spending from a $2M portfolio won’t go nearly as far in 40 years, as even with just 3%/year inflation, the purchasing power of those distributions will be cut by nearly two-thirds! Nonetheless, even after adjusting for inflation, taking a 4% initial withdrawal rate from the portfolio, and supplementing with Social Security benefits, would allow you to maintain and fully replace your pre-retirement spending during your retirement years.
More generally, the whole principal of saving for retirement is the basic recognition that if a household wants to equalize its spending over time, it must forgo some consumption in the early years (i.e., spend less than it makes and save the rest) in order to have dollars to cover spending needs in the later years (when there’s no longer any income from employment). Some researchers have even tried to develop “National Savings Rate” guidelines to help accumulators understand what percentage of income to save at various ages to replace their income in retirement.
This concept has been embodied in the economics research as the Life Cycle Hypothesis by Modigliani and Brumberg. And in fact, while households do face some difficulty to perfectly apply the theory – not the least because there’s uncertainty about how long they will live in the first place – the theory has generally been empirically validated over the years, and we find that at least many households really do seem to pursue an effort to maintain constant spending over time, saving excess income when possible during the working years and then spending it down later in retirement.
How Family Disrupts The Percentage-Of-Income Saving Approach
Notably, while it appears that households do try to save income during their working years to have assets available to fund retirement, it’s not necessarily done in practice by simply saving a steady percentage of income throughout.
Sometimes, the percentage-of-income approach fails because of “lifestyle creep” as one’s standard of living lifts up over time (which distorts the required savings percentages over time). In other cases, getting a big raise can lead to a permanent change in lifestyle spending, which means accumulators may need to save a percentage of their raises (not just a percentage of their income) to keep up.
But for many retirement accumulators, the biggest disruption to saving a percentage of income is the remarkably common decision to start a family and have children.
From the perspective of saving, the addition of children to the family picture raises immediate questions, such as “is it better to save first for college, or retirement?” Although for most families, the biggest issue is not where to send the savings, but the mere fact that it’s suddenly much harder to save once kids are brought into the picture! In fact, in a world where a young adult might only be saving 10% or 20% of income, and it costs an average of almost $250,000 just to raise a child, for many families the introduction of children means savings goes straight to zero when the kids arrive!
In other words, the cost of kids can crowd out retirement savings altogether for an extended period of years. And an extended period of time during the child-rearing phase where no saving is happening (or the saving is going towards future college expenses rather than retirement) means that by the time retirement arrives, there's now a retirement savings gap - a shortfall that was created by the years when saving for retirement just wasn't feasible.
Accordingly, for those who ultimately do want to retire and maintain their lifestyle, the consequence of a decision to add children to the picture is that it forces a reduction in other spending, too. In other words, the household has to go through an extra round of belt-tightening, just as the kids arrive, to be able to still save during the child-rearing phase, and at least reduce the size of the shortfall attributable to raising a family. Even then, the retirement standard of living may end out being a bit lower than what it would have been before.
Notably, though, even for families that are able to reduce spending during the working and family years, the “save a percentage of income” approach is still out the window. The savings window is still much smaller during the child-rearing phase than it was when they were still young adults (before having kids), and what can potentially be saved again after raising kids (during the “empty nest” phase before retirement).
Using The Empty Nest Phase For Retirement Catch-Up
Given these dynamics, it is perhaps no surprise that one study after another continues to show that those in their 50s approaching retirement are quite far behind on their retirement savings goals and lack confidence in their own preparedness for retirement. Because for many in this phase, they have just recently come out of the child-rearing phase, and not surprisingly have little retirement savings to show for it.
Yet indirectly, this also makes the point of why the “save a percentage of income” approach is ineffective. Because those in the empty nest phase have a unique opportunity to save a particularly large percentage of their income and play “catch up” as the family expenses wind down! In other words, saving a percentage of income as a young adult becomes unrealistic in your 30s and 40s as kids crowd out the ability to save much at all, and then understates the saving need (and opportunity) in your 50s and early 60s once the kids are out of the house!
In turn, what this suggests is that the transition into the empty nest phase is actually the key moment for retirement savings. For those who continue their family spending at the same pace - substituting what were previously parenting expenses with other spending as more free cash flow becomes available - the retirement savings gap will remain as large as it ever was. Or even worse, higher lifestyle spending during the empty nest phase just makes the couple face even more of a retirement shortfall, as the already-meager retirement savings definitely cannot support the higher empty-nest-phase spending pace.
On the other hand, for those who allow their total family consumption to fall (now that Mom and Dad are only supporting Mom and Dad, and not the kids), a significant uptick in savings can almost entirely make up the lack of savings during the child-rearing phase. In other words, if all the money that used to be spent to raise a family and send kids to college is now redirected into saving for retirement, a couple might find themselves suddenly leap from saving less than 5% of income to being able to save 25% or more!
In essence, then, what happens to the spending that "used to be spent" on the children creates a form of "empty nest red zone" - a key chunk of spending for a period of years that can dominate the outcome of whether the couple successfully reaches retirement later, or finds themselves facing a worse shortfall than ever.
In fact, the assumptions made about this “empty nest red zone” – what happens to the extra expenses associated with kids during the child-raising years that becomes “available” in the empty nest phase – is a key factor in determining whether most households are really behind on retirement or not.
For instance, the Center for Retirement Research notes that the National Retirement Risk Index (NRRI) finds a whopping 52% of households may be at risk for a retirement shortfall. However, a study by Scholz, Seshardi, and Khitatrakun in the Journal of Political Economy found that the number of households facing a shortfall is less than 20%, and the deficit for those who are undersaving is relatively small.
And how do we account for the dramatic difference in outcomes between the two studies, and whether today's 50-somethings are really behind on their retirement savings or not? The primary difference between the two: how they account for the empty nest red zone. While the NRRI analysis assumes level spending throughout the working years and retirement, the Scholz et al. study assumes that empty nesters save more once they are able to (and also that retirees spend less in the later years of retirement), and these considerations actually eliminate a huge portion of the retirement readiness gap altogether!
Implications Of Uneven Household Spending During The Child-Rearing Years
Ultimately, the implications of considering how household spending is likely to be “uneven” during the child-rearing family phase is significant.
First and foremost, it implies that doing limited or even zero saving during the child-rearing phase – or conceivably even “negative” saving and accumulating some debt – is actually normal, and expected, and absolutely fine... as long as the couple is prepared to maintain their personal spending after the kids leave the house and use the empty nest phase as an opportunity to finish their retirement saving. In other words, making parents in their 30s and 40s feel guilty for not saving enough is unnecessary (and in some cases even cruel to suggest).
Second, it suggests that the crucial moment to focus on is specifically how parents adapt their spending as they transition into the empty nest phase. At this juncture, “just” returning to their pre-family habits of saving a moderate percentage of income may be wholly insufficient, but saving a larger percentage may actually be quite feasible and realistic. However, the prospective retirees need to be warned and prepared in advance that the empty nest phase is not a license for spending their newfound discretionary dollars, but instead simply a normal opportunity to make up for prior years when saving just wasn’t feasible!
On the other hand, it’s worth noting that as the median age for starting a family continues to rise, the entire process of when kids cause savings to be reduced, and in turn the onset of the empty nest phase when savings can rise again, has been shifted later in the lifecycle; in other words, we get to the child-rearing phase later, and then we come out of it much older (and potentially much closer to retirement). To the extent that the full retirement age for Social Security has also shifted later, though, and medical advances have given us more productive working years, this may not necessarily be a problem. Although indirectly, it does emphasize the importance of a social safety net for those who unfortunately find themselves unable to work in their 50s and 60s, just as the empty nest phase – and higher retirement savings – were otherwise “supposed” to kick in.
Nonetheless, the fundamental point remains that the feared “retirement shortfall” for those in their 50s and early 60s may actually be significantly overstated, and that the key conversation to have is not about the doom and gloom of having too little in retirement savings already, and simply the opportunity that exists to quickly make up the shortfall during the empty nest phase. After all, the reality is that even with a “normal” savings trajectory, a retiree who wanted $1,000,000 at retirement would have less than half that amount with a decade to go. Someone who had the ability to save aggressively – thanks to available discretionary income during the empty nest phase – can bridge the gap even faster.
For instance, a couple earning $100,000 that reaches the empty nest phase (and their peak earnings years!) in their early 50s and still has 15 years left for retirement can accumulate over $1,000,000 of retirement savings by “just” saving 30% of their income and investing for growth (an 8% growth rate). While there’s some retirement date risk that market returns may not align perfectly, that’s still a remarkable “catch-up” in retirement savings for someone who might have hit the empty nest phase with $0 in their retirement accounts! And if they had anything more than $0 of retirement savings as they transitioned to the empty nest phase, the outcome would just be even better!
The bottom line, though, is simply this: perhaps it’s time to stop guilting parents in their 30s and 40s about not saving enough, and recognize the savings opportunity for empty nesters in their 50s and 60s. Because telling parents to save 10%-20% of their income during the child-rearing phase may be unrealistic, and telling empty nesters to save 10%-20% of their income may underestimate their ability to save and get their retirement on track!
So what do you think? Do we put too much pressure on parents to save during the child-rearing years? Is it better to recognize that realistically, most parents will do most of their savings during the empty nest phase? Please share your thoughts in the comments section below!
Intriguing. As a soon-to-be empty nester, I was thinking we could finally put some money into deferred home improvements. Might be smarter to jack up retirement savings.
The only thing I see that is not well covered here is the discussion of many families I encounter that still had to take sizable college loans and now feel they owe it to their kids to pay those loans or leave their kids encumbered with debt they may not escape for 20 years. I advise that they still focus on their catch up retirement savings and if cash flow allows them to pay the interest accumulation on the loans then do that. The heart of this issue is the challenge for parents to help kids with dreams make a very tough business decision to go to an affordable school rather than take on debt for the dream private education or forgo scholarships at a lesser school. We deal in dreams. Encouraging parents to potentially dash their kids dreams about higher education is a difficult paradox.
An interesting approach but it does not take into account possible economic cycles and the increasing tendency of corporations to downsize expensive employees in their 50’s and 60’s. This happened to many people who were planning to do catch up savings just prior to 2008.
And the downsizing is still happening for those expensive employees over 50.
yes and they often take what they have saved for retirement to start that entrepreneurial venture after being downsized in their 50’s or 60’s.
Some become Financial Advisors….
Good insights into later-stage power saving over questionable (and mostly unrealistic) retirement-prep guidance to young families. Most savings at that phase should probably go toward emergency funds to cover the frequent contingencies that kids bring. That said, we’re in a phase where permanent custodial parenting is becoming the norm (http://www.pewsocialtrends.org/2016/05/24/for-first-time-in-modern-era-living-with-parents-edges-out-other-living-arrangements-for-18-to-34-year-olds/). I’d value an article by Michael with his thoughts on this trend’s impact on retirement savings.
Interesting article but it doesn’t address the fact that many people are not able to continue working until age 65 due to poor health or job layoffs. It assumes a savings rate of 30% for 15 years but that may not be realistic. Personally, I would rather save sooner rather than later to ensure enough money is available in retirement instead of running the risk of not having enough.
My wife and I were able to save during our child-raising years because we participated in 401k/403b plans at work. Both plans had generous matches. My plan had an extra employer contribution of 10% of pay. And of course we were each contributing to Social Security. Any extra money went toward feeding, clothing, and educating three children. Since we will hit retirement age very shortly after the last child finishes college, it’s a darn good thing we were in those plans. Even with that, I intend to work until age 70. I should mention that refinancing for a new kitchen 10 years ago pushed back the date of paying off the mortgage by five years.
As a father of a high school senior and a 3rd grader, I can certainly relate to the delicate balance between saving for retirement and spending for my kids’ education. As a CFP, my “standard” recommendation to clients is to take care care of themselves first and let their children have some “skin in the game”. Easier said than done for sure. I wonder whether issues raised by Michael also speak to a larger dilemma we face as a nation. By that I mean the only way we can take care of future retirees is to invest in our children. But that is a whole other conversation.
This essentially is what I’ve done, power saving after my youngest’s graduation from college in 2010. The cost of day care and higher education has skyrocketed and it was damn near possible to save any more than the matching amount over the years.
One unfortunate item: I began working for local government in 2007, and despite the promise of annual salary increases, I’ve only received three of the eight that were part of the initial hiring agreement. This type of executive deal-breaking is why unionization of government employees continues to rise.
The other wild card: will you need to support a parent or adult child? We have a MI 43 y.o. child and my mother is now 83 with no way to pay for long-term care (my father died 32 years ago).
Very good article. Have not seen this concept presented elsewhere.
The transition is definitely something to manage. But you can’t count on that period for the many couples who won’t become empty nesters until their 60’s or even later.
Plus, parents in their 20’s adn 30’s are usually also paying off their own college student loans!
As for the empty nesters, your observations show how important it is for parents to get to the empty nest stage – nudge those fledglings to fly the coup! I’m see too many unfledged 20-somethings in my client base!
The key to a successful retirement is “paying yourself first”-always, and no matter what. Far too many people live their incomes. And being frugal is essential. Send your children to a good public university-if they wish to advance to graduate/medical/law school-that’s where you invest the money-for a top school.
Retirement? Again, frugality is truly the key. Very reduced fixed monthly expenses mean less income is required from your portfolio. And if you don’t own a robust long term care program? Then forget it, all bets for success are off. Because your care costs exposure of if, when, how much, one or both spouses and for how LONG etc. is open ended-massive long term care costs can destroy your retirement savings.
In a perfect world, this approach is worth deploying. However, I agree with Dr Gresham that the uncertainty of economic cycles precludes the 50-something from utilizing this as the only retirement strategy.
I would say one’s appropriate standard of living should always incorporates sizeable retirement contributions throughout the entire working period, which I would define as a minimum 10% of gross income, but more ideally 15-20%. So, if the “family plan” is going to involve kids, then that means cuts should be made somewhere else. That might also mean you’ll need to move to a less expensive part of town, or to another state all-together, selling or downsizing a car, cancelling that expensive cable TV package, etc. It might also mean, dare I say, as many kids as you’d prefer to have.
As for kids college, I would say try to incorporate a modest, automatic 50-$150/month contribution, the moment a child is born, to be auto-invested into one’s state’s 529 plan (provided its decent). However, limit this effort to always still being able to maintain at least 10% of gross income being devoted to retirement contributions per above. Provided that retirement contributions are not suspended in the early phase, a family “may” be able to outright suspend retirement contributions, say, in their 50s and funnel all of this money into college expenses if said family unit is on-track to hit “their number” without additional contributions at that point.
I’ll close with that catch line you CPAs are fond of saying; one can always borrow for college, but you can’t borrow for retirement.
Empty Nest “catch-up” is, of course, among other factors, subject to:
1) initial adverse returns during the catch-up period, which could have a very serious negative impact upon aggregate savings.
2) “prodigal son(daughter) syndrome” – recent news blurbs have revealed that when the realities of marginal post-college wages confront the erstwhile graduate, more than 30% show up on mom/dad doorstep, with all the consequent economic impacts to the family budget, regardless of initial parental edicts.
I propose a different approach, based only upon my supposition that “golden opportunities” in early childhood/adolescence” have an inverse effect upon later adult success. Stated colloquially, sending junior to baseball camp may be gratifying, but it will have a negligible impact upon the college career and much less upon later career success. Consequently, pay yourself first while junior is still bike-bound; increment the financial commitments to offspring as college nears (and as they earn the commitment..) and in the meantime, favor contributions to the retirement funds. This is an iron-clad logical course of action. Now, I just need to figure out how to convey it effectively to clients….. and implement it myself…..
Not mentioned is the investment knowledge, experience and temperament obtained by starting early and when balances are small and growing; so those traits are well burnished by the time the balances are more meaningful.
Great Article Michael. And, I can testify that you are correct, based on my own history.
Great Article…and I can testify, from personal history, that you are right!