PLANNING for retirement requires making small sacrifices early to enjoy a better future.

In Jamaica, individuals can now contribute a maximum of 20 per cent of their gross salary towards a pension plan. Since your pension should provide a monthly income upon retirement and income earned from contributions is tax free, employees or contributors to a pension plan should consider increasing their pension contributions whenever they receive an increase in salaries.

However, in the public sector, the maximum pension contribution required by employees is five per cent of their gross salary, and pension payout is based on a pre-determined formula. Having long-term investments to supplement pension benefits is very important for all pension contributors, especially for employees in the public sector.

What happens when employees receive a salary increase? Does spending increase or do employees save or invest more? Retroactive payments are salaries, too. But what percentage of these payouts are saved or invested?

In Jamaica, nearly 20 per cent of the working population contributes to a pension plan. Based on research by the Economic Policy Institute in the USA, “nearly half of American families have no retirement savings at all”. Some financial experts recommend that employees contribute 15 per cent of their gross salary to a pension plan, this is inclusive of the employer’s contribution in order to maintain a comfortable lifestyle in retirement. I recommend that employees should seek to contribute the maximum 20 per cent stipulated by law. The more of your income that can be invested tax free, the more rewarding it will be in retirement.

Lifestyle creeps

In some instances, pay increase can be so low that it has no impact on pension savings. Research also shows that regardless of the size of salary increases, workers may not save or invest more due to “lifestyle creeps” or “lifestyle inflation”. This term refers to situations in which one’s standard of living gets better and more disposable income is used to purchase non-essential commodities. What once were luxuries, become necessities. The thinking is, they have earned the right to have luxuries rather than seeing luxuries as a choice. As British historian C Northcote Parkinson said, “A luxury once enjoyed become a necessity.” The bottom line is our behaviour towards money. How we spend or invest salary increases throughout our working years helps to determine the standard of living we enjoy in retirement. When we get a raise in salary or a major promotion, do we spend on our wants or necessities? A new car may seem attractive, but is it a necessity? Moving to a bigger apartment or buying a bigger home may suddenly seem within your reach, but in the long run, how much more will it cost you?

The solution

Recently, a client told me that she received a salary increase and decided to purchase a new car. Her financial advisor warned her against making that decision. She delayed the purchase. A few months later, her position was made redundant. Had she purchased the new car, how would the car payments be maintained? Getting sound financial advice is necessary to avoid lifestyle creeps. Whenever employees receive salary increases, it’s an opportunity for a financial review. Don’t make decisions in a hurry. Many employees don’t save more when they receive a salary increase. Therefore, a mindset change is required to make saving a habit, regardless of the size of the increase. Small amounts add up over the long term. The closer you are to retirement, the more of your income you should save as there is less time to compound your money. Automate your savings as much as possible.

United States research company Morningstar Inc recommends several rules of thumb to determine how much money you should save from your salary increase. The first rule is to spend twice your years to retirement. Therefore, if you are 15 years to retirement, 30 per cent of your raise should be spent and 70 per cent saved for retirement. The next rule is to save your age as a percentage of the raise. If you are age 50, save 50 per cent of your raise for retirement. Rule number three is to save a minimum of 33 per cent of your raise. Spending twice your years to retirement has proven to be the most successful rule of thumb. I recommend, however, that persons saving for retirement consult with a professional financial advisor who can offer an analysis based on each individual’s unique situation.

Grace G McLean is financial advisor at BPM Financial Limited. Contact her gmclean@bpmfinancial or visit the website: www.bpmfinancial.com. She is also a podcaster for Living Above Self. E-mail her at livingaboveself@gmail.com