A no-brainer way to save for retirement

Basically, it works like this: Whenever you get a pay raise, some of it automatically goes to increase your 401(k) contribution. You do nothing. (This is good, because scientific research indicates that's what you'd be doing anyway.)

Raises . . . and beyond

But I say, Why limit it to pay raises? You can apply the Save More Tomorrow strategy to all of life's little windfalls:

• Tax refunds

• Bonuses

• Birthday and holiday money

• Yard-sale profits

• An inheritance

Instead of upgrading your lifestyle, you can save these dollars you've already learned to live without and put them toward retirement or another big savings goal, like a down payment on a house, a college fund, a new roof or a big trip.

It doesn't sound like fun at first. Whenever I get a little extra money, sugarplums dance in my head: Ooh, maybe now I'll buy an iPod or new dining-room chairs. Keeping your lifestyle as it is today ain't sexy.

On the other hand, setting aside money before it becomes an indispensable part of your budget is like free savings. And it adds up.

A test case

We used Jill, in her mid-30s, one of our Women in Red, to test-drive the concept. She had stopped making retirement contributions when she left her old job (see "inertia" above). Still, she's got $26,000 in that old 401(k) that she can build on.

If Jill were to get a 3% pay raise each year and invest it in her 401(k) (she earns about $80,000) between now and age 65, and assuming an 8% return, she'd have about $5 MILLION saved.

Or let's say Jill earned $48,200, which is the median household income in the United States, meaning half of all households earn less and half more. And let's say she contributed just two-thirds of her 3% raise each year and started with zero dollars in her 401(k). She'd still end up with more than $1.5 MILLION, and the remaining one-third of her raise would give her a little extra to spend each year or help her keep up with inflation as the years go by.

(You math whizzes have probably already figured out that the size of her retirement contributions in later years are pretty huge. But now that the maximum contribution amount ($15,500 in 2008) increases to adjust for inflation, you can use the Save More Tomorrow strategy indefinitely to supersize your retirement savings.)

Even though a million or two sounds like a fat nest egg for a retiree, remember it won't go that far in 30 years. It will take $116,500 in 2037 to buy what $48,000 does today (assuming 3% inflation), and you would need nearly $3 million to generate that much income. Thus it pays to 1) figure out what you'll need to retire and 2) max out the savings opportunities that will get you there.

Back to savings

So the Save More Tomorrow plan isn't a miracle, but it's as close to a no-brainer as you can get without handing your paycheck over to Mom.

You and I may not have access to the official Save More Tomorrow plan through work, although Thaler says that a couple hundred companies have embraced the idea. But it's possible to create the same effect by keeping your lifestyle steady and using raises and other windfalls as your savings source.

Even free-lancers like me can approximate the SMT effect, says Madrian. Rather than waiting for a raise (which can be hard to gauge with an erratic income), Madrian suggests setting aside a certain percentage of every free-lance check (say, 10%) and putting that into an IRA, if retirement is the goal, or into a savings account, and then increasing that percentage as your overall income grows.

"Whatever you do, you don't want that money in your spending account. You need to put it into savings immediately -- or it will be gone," she says.

As time goes by . . .

The Save More Tomorrow strategy starts out slow but picks up dramatically as time goes on. If you're the median householder earning $48,200 and getting a 2% raise each year, at the end of six years you'd have about $24,000. Swell, but not terribly exciting, right? But just two years later you'd have almost $44,000. Now it's starting to get interesting!

Here's how those little 2% contribution increases can grow into a big pile of cash in just 10 years (invested in stock mutual funds returning an average of 8% a year):

Those 2% raises add up
Contribution	Income	Raise amount	Starting balance	Ending balance
--	$48,200	$964	--	$964
$964	$49,164	$983	$964	$2,988
$1,947	$50,147	$1,003	$2,988	$6,177
$2,950	$51,150	$1,023	$6,177	$10,644
$3,973	$52,173	$1,043	$10,644	$16,511
$5,016	$53,216	$1,064	$16,511	$23,912
$6,080	$54,280	$1,086	$23,912	$32,991
$7,166	$55,366	$1,107	$32,991	$43,903
$8,273	$56,473	$1,129	$43,903	$56,817
$9,402	$57,602	$1,152	$56,817	$71,916

The important thing to remember is that every little bit counts. Madrian says it's like dieting. If you want to lose 20 pounds, but then dessert comes around and you decide to put off dieting until tomorrow, all those tomorrows add up pretty quickly "and in six months, that's a lot of extra weight," she says.

"It's the same with savings. If you don't do it today, the teeny bit of interest you lose isn't very big. But if you add that tiny amount up, that's a significant amount you'll save."

So start saving more for tomorrow -- today.

Updated Dec. 7, 2007

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