Saving graces: Americans put away minimum

Most people have heard Benjamin Franklin's old adage: "A penny saved is a penny earned." In a recent paper, Bill Montague, a consulting group senior financial writer, examined how these days many Americans act like they don't believe it.

For years, Americans have spent more and saved less of their incomes than the inhabitants of almost any other major industrial country. Lately, however, the personal savings rate has plummeted to new record lows - so low, in fact, that the average American is now spending more than he or she earns, according to government statistics.

Some economists warn this trend has left the United States dependent on foreign investors to provide the capital needed to fund investment and finance the federal budget deficit. If those investors were to lose their taste for U.S. assets, interest rates could jump and stock prices could fall, hurting the economy.

Other analysts are less alarmed, saying official statistics exaggerate the savings shortfall - for example, by not counting the capital gains many U.S. investors have earned on their stock and bond portfolios or on the value of their homes.

Whatever the merits of these arguments, the debate highlights the importance of the issue - both for the economy as a whole and for the financial security of individual investors. One risk is that investors may be overestimating future capital market returns, and thus underestimating how much they will need to save in order to reach their financial goals.

For this reason, investors may want to take a hard look at their current spending and savings habits. They may also want to consider taking advantage of recent tax law changes designed to boost savings, such as by allowing older investors to make extra "catch-up" contributions to their 401(k) plans and other tax-favored accounts.

It's probably no coincidence that the savings rate declined especially rapidly in the mid-1980s and again in the mid-to-late '90s - both periods when soaring stock markets were fattening investor portfolios. Likewise, the most recent decline may be connected to the real estate boom, which has boosted household wealth and made it easier for many consumers to borrow against their home equity. Under such conditions, savers may see less need to add to their nest eggs.

Optimists argue that household wealth - which rose from $12.7 trillion to more than $48 trillion over the two decades ending in 2004, according to the Federal Reserve - is a better indicator of financial health than the falling savings rate. However, after taking inflation and population growth into account, those gains look less impressive. Over the same 20-year period, real per capita wealth rose a bit more than 68 percent - an annualized gain of just 2.64 percent.

Focusing on total household wealth can also be misleading, since it groups high net worth households, which have seen substantial gains in recent years, together with less-affluent savers, who are more likely to have trouble funding their retirement needs.

A recent survey by Hewitt Associates, a human resources consulting firm, found that the median balance (meaning half were above and half below) in 401(k) plans among investors in their 50s was just $53,400 - far too low to meet the financial objectives of most retirees, even assuming a return to the relatively high capital market returns seen during the '80s and '90s.

For those who've gotten a slow start in the savings race, Uncle Sam is now offering a way to catch up. As part of a 2001 tax cut bill, Congress added a clause that allows savers aged 50 and over to make extra "catch-up" contributions to their Individual Retirement Arrangements or 401(k) plans. In 2006, those additional contributions can be as high as $5,000 for 401(k) plans, $1,000 for regular IRAs and $2,500 for so-called simple IRAs. Starting in 2007, those limits will be indexed for inflation. Another plus: Catch-up amounts aren't covered by the 401(k) contributions limits placed on some highly paid employees.

The catch: The catch-up provision expires in 2011, and there's no guarantee Congress will renew it. Also catch-up contributions are only available in 401(k) plans that allow them. Currently, about 90 percent do.

For most people, developing disciplined savings habits - and sticking to them - is a critical part of any successful financial strategy. Prudent long-term planning can help investors find the appropriate balance between spending and savings. So can understanding the benefits and drawbacks of the different savings vehicles available to them - including tax-favored accounts.

For more information, e-mail william.a.creekbaum@smithbarney.com or call 689-8700.

• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial services firm serving Northern Nevada at 6005 Plumas St., Ste. 200 Reno, NV 89509.