How Much of Your Income Do You Need to Replace in Retirement?

By Carrie Schwab-Pomerantz

March 5, 2020 7 min read

Dear Carrie: I've heard that, generally speaking, you can get by on 70-80% of your annual income in retirement. Is that really a reliable estimate? — A Reader

Dear Reader: A lot of people would certainly sleep better knowing they had enough money to live comfortably in retirement. That's why we have approximations like the 70-80% guideline. They give people an estimate to work toward, which is a step in the right direction.

But a guideline is one thing, and reality can be another. So your question gets right to the heart of the matter: How much of your annual income do you really need to live comfortably in retirement? If only the answer were as simple as the question.

Guidelines Are Static

While I'm all for giving people a starting point, one limitation of guidelines is that they assume life is a constant, which is far from reality. For starters, are we talking about 70-80% of your income needs at age 40 when you might be raising a family, saving for your children's college and carrying a large mortgage? Or your income just before retirement when your financial obligations are most likely very different? Should it be based on your peak earning years? And are we talking about gross income in a single year or net income? (Generally, it's considered gross income, not your take-home pay.)

Plus, the result of using a single year's income as a basis might be that you end up with less money than you need for the standard of living you envision in retirement — or, conversely, it might have you struggling to save more than you'll actually need.

Retirement Is Dynamic

Another assumption is that retirement expenses will be constant. That, too, isn't accurate. While certain essential costs of living may remain the same — and some costs may go down, such as work expenses, taxes and mortgage payments — the way retirees choose to spend time during different phases of retirement may require more or less income.

For instance, you may have heard the concept of the "go-go," "slow-go" and "no-go" years. Often retirees spend more in their early retirement years on things like travel and entertainment, and may need 100% or more of income to live the lifestyle they want. The middle retirement years may be focused closer to home, with more nights in than dinners out, and expenses may go down. Costs in the later years of retirement can often be a function of health and longevity, with medical and long-term care costs warranting a larger percentage of income. Retirement spending isn't a straight line.

Research has shown that while some retirees need more than 80% of their previous income throughout retirement, others can get by with closer to 50%. And those percentages can fluctuate within the course of a retirement. It's very individual.

Your Situation Is Unique

General guidelines can't factor in things like your risk tolerance, the size of your family or your lifestyle. These are unique to you. So bottom line, to understand how much you will need to have a comfortable retirement, you have to get specific.

Start by doing a sample budget. You might divide it into three categories: needs, wants and wishes. Needs are the things you can't do without like housing, everyday living, health care, insurance and taxes. Wants are the nice-to-haves like travel and nights out. Wishes are where you can let yourself go including all the things you'd do if you had unlimited time and money. Now it's up to you to decide what's realistic.

With your lists in front of you, add up your sources of reliable retirement income: Social Security, a pension or income from an annuity. Your savings will have to make up any difference between the total of your income and your spending.

The percentage of income you need to replace in retirement to cover your projected expenses is also a function of how much discretionary income you have. If money is tight and you use most of your income to cover essentials, chances are you'll have to replace a larger percentage of that income in retirement just to get by. If, on the other hand, you've had the good fortune to have a fair amount of discretionary income, you may have more latitude in deciding how you might cut back in retirement and consequently replace a lower percentage.

Boost Your Confidence With a Personalized Plan

To get back to your question, I think it's OK to use the 70-80% guideline if you're pretty far from retirement and only looking for an approximation. Using a higher percent guideline is better if you're more conservative. Either way, the closer you get to retirement, the more specific you need to be.

To me, the key to confidence is to plan ahead. Recent research by the Employee Benefit Research Institute found that only 42% of people had actually tried to calculate how much they'll need to save to live comfortably in retirement. And that's where the uncertainty comes in. On the positive side, Schwab's 2019 Modern Wealth Survey found that 56% of people who were planners felt "very confident" they would reach their financial goals compared with only 17% of nonplanners.

So to really understand how much retirement income you'll need, dig into the details. Plug some numbers into a retirement planning calculator. Consider talking to a financial planner who can help you with how much you can spend, discuss how inflation and taxes come into the picture, and put together some what-if scenarios based on your personal situation.

In the meantime, pay off your consumer debt. Consider reducing fixed costs like a mortgage. And even experiment with living below your means. That way, you'll not only be able to save more now while you have your full income; you'll get used to living on less. That may be the ultimate way to personally understand what percentage of your income will be enough to live comfortably and confidently through all the phases of your retirement.

Carrie Schwab-Pomerantz, Certified Financial Planner, is president of the Charles Schwab Foundation and author of "The Charles Schwab Guide to Finances After Fifty." Read more at http://schwab.com/book. You can email Carrie at [email protected] The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. To find out more about Carrie Schwab-Pomerantz and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.

DIST BY CREATORS SYNDICATE, INC. (#0220-0GTS)

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