70 – 85% of Pre-retirement Income – Do You Really Need That Much For Your Retirement?
As we plan our retirement finances, we have all run into the widely accepted “rule of thumb” that we will need 70 – 85% of our pre-retirement income as our income after we retire.
It seems strange that this percentage can be applied across all retirees since there are so many variables that can affect each individual situation.
While reading SPEND til THE END by Dr. Laurence Kotlikoff, Professor of Economics at Boston University and Scott Burns, nationally syndicated financial columnist, I found the source of the 70 – 85% rule — and was I surprise what I found out about it.
According to the book, the replacement rate is calculated every three years by the Center of Risk Management and Insurance Research at Georgia State University. The calculation began in 1969. It is based on the Department of Labor’s Consumer Expenditures Survey. The research project is funded by AON Corporation, an insurance brokerage, consulting, and underwriting firm based in Chicago.
SPEND til THE END takes you through how the number is derived. Take a couple just preparing to retire who are making a combined salary of $70,000 and subtract the various current expenses that will not apply after retirement as follows:
Combined Pre-retirement Salary $70,000
Less Pre-retirement
FICA 5,355
Federal Income Tax 7,040
State Income Tax 1,678
Retirement Savings 2,421
Related work expenses 1,975
Plus Retirement
Federal Income Tax 1,264
State Income Tax 278
Total Retirement Income $53,073
Replacement Rate 76%
That is the replacement income percent as shown by the authors in SPEND til THE END. It seems so logical and straight forward, but it will probably be wrong for most people. One size does not fit all in this calculation.
Take your individual case. If you are paying your mortgage into your retirement, will it be paid off a few years after your retirement? If this is the case, your required retirement income will be substantially less than the standard 76% will indicate.
Is your spouse considerably younger or older than you? If one spouse passes away long before the other, there will be a long time when your retirement savings have to support only one person. This is not factored into the 76%.
Will you still be supporting children or parents at retirement? This support will not go on all during your retirement (you hope!). When the support stops, your spendable income will rise considerably. This is not considered in the rule of thumb 76%.
As you can see from the above examples, the 76% might significantly overstate the amount of income you will actually need for your retirement.
Before you believe the 70 – 85% rule, calculate your actual current expenses. Then consider each one to determine what your true retirement living expenses will be. You might have expenses which will rise during retirement such as travel or medical care. You will find guidance on calculating retirement expenses on the Best Retirement Calculators website.
Visit SPEND til THE END.com for more information about this revolutionary and interesting book.