How to Catch up After a Retirement Savings Break

After an employment gap, here’s how to resume a retirement savings plan.

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There are a number of reasons people temporarily stop saving for retirement: job loss, to care for children or elderly parents, to return to school, or to cope with medical expenses. But once you begin saving for retirement again, you will need to boost your savings rate to make up for the gap. "Being unemployed for a year is something that one can overcome when it comes to retirement savings, but they will need to save more and save faster and invest in a way that makes sense for them," says June Walbert, a certified financial planner for USAA Financial Planning Services. How much more depends largely on your age and the length of time you weren't saving. Here's a look at how to catch up on retirement savings after a break.

[See How to Save for Retirement on a Low Income.]

Young savers. A break in retirement savings during your 20s or 30s has the biggest impact on your final retirement account balance because of all the compounded returns you'll be missing out on. But young savers can make up for the lost savings with relatively small increases in their retirement account contributions because their nest egg still has many years to grow before retirement. "If you're in your 30s and you stop working for a year, you will have another 30 years to make it up," says Elaine King, a certified financial planner and managing director of wealth planning at Lubitz Financial Group in Miami.

Consider a worker who earns $40,000 at age 25, receives a 3 percent raise each year, and saves 13 percent of her salary annually, including an employer match, in a 401(k) account. If she continues this saving rate throughout her entire career, she would accumulate $500,000 by age 65 in today's dollars, assuming a 7 percent annual return and 3 percent annual inflation. This would replace about half of her preretirement salary. But if she delays saving for retirement for five years until age 30, she will only be able to replace 39 percent of her preretirement salary from her portfolio at age 65 unless she saves more, according to T. Rowe Price calculations. To replace half of her income in retirement after beginning saving at age 30, she will need to boost her savings rate to 17 percent of her salary each year. "When you're in your 30s, you still have years for the money to compound," says Christine Fahlund, a senior financial planner with T. Rowe Price. "When you need to catch up after your 30s, you only need to increase your saving somewhat."

[See Retirement Savings Strategies for Late Starters.]

Older savers. The nest eggs of savers closer to retirement will be less damaged by gaps in saving, but the increases in contributions required to catch up are much larger. "When they do find another job, they really are going to have to put a lot of other things on hold in order to save as much as they possibly can for retirement," says Walbert. For example, a 55-year-old who saved continuously throughout her career would still be able to replace 46 percent of her salary in retirement if she took the next five years off from saving, compared with 39 percent for a 25-year-old with a five-year retirement savings gap, T. Rowe Price found. But getting back on track will be much more difficult for the 55-year-old. When the 55-year-old resumes saving at age 60, she will need to save 27 percent of her salary to still replace half of her income in retirement, versus the 17 percent savings rate the 30-year-old needed to make up for an employment gap of the same size. "If you don't save when you are young, you are going to have much heavier lifting when you are older," says Fahlund. "If you do save when you are young, you are going to have much more freedom to do other things with your money once you get into your 50s and 60s because your nest egg is already significant in size."

[See 10 Places to Retire on Social Security Alone.]

Advance planning for career gaps. Workers could alternatively prepare for expected or unplanned gaps ahead of time by saving more than they need to while they're employed. If you know you are going to take a few years off to raise children or you work in an industry where layoffs and business closures are common, it's wise to tuck as much as you can into retirement accounts while you are working so that money can compound during your career break. For example, if you calculate that you need to save 13 percent of your income annually to meet your retirement income needs, consider saving 15 percent while you are employed. Saving 1 or 2 percent more than you will need for retirement will allow you to absorb the impact of a temporary saving hiatus. "Before the children come along, you really need to save aggressively and max out an employer-provided plan," says Walbert. "If you are expecting periods of unemployment you should, well in advance of that, make sure you have plenty of money in your rainy day fund so that if it does start raining, you can survive without cashing in your 401(k)."