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Want to save more for retirement? Do the math!

(MoneyWatch) Welcome to the second of my posts that explores the reasons why Americans don't save enough for retirement and provides possible solutions. My last post offered three reasons why Americans don't save enough money:

  • Lack of knowledge about the amount of money needed to be set aside for a comfortable retirement
  • Not enough money left over in their budgets after covering their monthly living expenses
  • Lack of motivation to divert money from today's spending to improve their future

That first post explored innovative, face-aging software -- Face Retirement -- from Merrill Edge that helps with the third factor (lack of motivation) by showing what you might look like in your later years. Research sponsored by the Stanford Center on Longevity shows that knowing what you might look like as you age might increase your motivation to ensure your "future self" is financially secure. 

For example, people who saw an age-enhanced photo of themselves were willing to save an average of 6.75 percent of their salary in a 401(k) plan, while the control group who hadn't seen such a photo said they would contribute only 5.2 percent of their pay.

While saving 6.75 percent of pay is certainly better than saving 5.2 percent, even the higher amount will most likely fall far short of the amount you need to set aside for a comfortable retirement. To help you improve your awareness of the amount you need to save for a secure retirement, Merrill Edge's Face Retirement software contains links to an easy-to-use retirement calculator.

I took this software for a test drive using the circumstances of the same hypothetical couple I used for my recent four-part series that reviewed existing online retirement calculators. In that series, I tried out seven different online retirement calculators to calculate the amount of money that a hypothetical couple should save, using consistent assumptions regarding their current age, salary and existing retirement savings, as well as their planned retirement age, life expectancies, and the amount of retirement income they would need.

The answers to the question of how much to save ranged from a low of 9 percent of pay to a high of 70 percent. The middle ground showed suggested contributions in the high teens and low twenties, when expressed as a percentage of pay. These amounts included both contributions made by individuals and employer-matching contributions.

I tried the Merrill Edge software and found it very user friendly, with sliders to adjust the input and voice help. Kudos in the ease-of-use department. Their software only calculates savings amounts for individuals, not for couples, so I used their software in a few different ways to try to be consistent with my prior calculations.

The initial results showed a range of suggested contribution amounts; more kudos for being realistic by showing there's not a single right number for everyone and that how the uncertain future plays out regarding investments, inflation, and our longevity, will tell us if we really saved the right amount. On the downside, the suggested contribution amounts were rather high, ranging from 47 to 75 percent of pay, amounts that are out of reach for most households.

I poked around to determine the reasons for the high suggested contribution amounts and found a default assumption that really frustrated me -- the calculator assumed that I wouldn't receive any Social Security benefits. But it'sfar too pessimistic to believe that Social Security will go away entirely, so I found the place in the software where I could include Social Security benefits in my projections. I also adjusted the expected lifetime of the couple to age 95 to be consistent with my previous calculations. As a result, I came up with contribution amounts ranging from 26 to 45 percent of pay -- still on the high side compared to the other retirement calculators. The high end of the range is still most likely out of reach for most households.

My conclusions? I strongly believe that using a retirement calculator is a much better choice than just guessing at how much you'll need to save, because most people end up guessing way too low. And the annual "retirement confidence" surveys from the Employee Benefit Research Institute consistently show that you'll be more confident about your retirement if you take time to calculate the amount you need to save for retirement.

But it's important to understand that the results you get from a retirement calculator are all based on you making a number of assumptions, so they aren't infallible. You'll be best served by understanding how your specific retirement calculator works and all the various assumptions that it makes, including the default assumptions. You'll want to use a retirement calculator that makes it easy to change the assumptions, and the Merrill Edge software also meets that goal.

My suggestion is that you input a few alternative assumptions regarding your life expectancy, expected retirement age and so on to see how the results vary. You may also discover that you'll need to adjust some important lifestyle assumptions, such as your expected retirement age or how much retirement income you think you'll need, in order to estimate when it's realistic to retire given how much you can afford to save.

Don't give up if you estimate contribution amounts that are high; instead, use this as motivation to save as much as you possibly can. Remember that determining how much to save is part art, part science. But eventually you need to pick a single number and save that amount, together with any employer-matching contributions you may receive. Then be prepared to revisit your calculations periodically.

Increasing your retirement savings often involves attacking the challenge on multiple fronts: increasing your motivation to put money away, improving your knowledge about how to save and finding money in your monthly budget so you can save more for the future.

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