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Retirement Income Rule of Thumb Debunked

This article was written by in Planning. 17 comments.


To retire comfortably, you’ll need to have an income of 80% of your maximum pre-retirement income.

That’s a common rule of thumb you hear trumpeted by financial planners. Unfortunately, it’s not accurate. It may give someone planning their retirement a basis for thinking about creating income during those years, whether from part-time work or income-producing investments, but it can also provide a false sense of security.

“The Mole” is an undercover financial planner who writes for Money Magazine, and he has a better way at looking at retirement needs. It promises to be more accurate. He believes that if you have to estimate something, you should estimate your expenses first, and work backwards from there.

Clients often come to me with this same question, and I can’t answer it without knowing how much they are spending. Some clients making $100,000 per year are only spending $50,000, while others are earning $110,000 and getting further in debt. So you should really ask, What percent of my current annual expenditures should I expect to spend in retirement?

Typically, unless they make drastic lifestyle changes, retirees will spend the same, if not more, than they did before retirement. The Mole suggests estimating your full expenses and adding 10% to that figure. Now you’ll need a way to come up with that income in retirement.

Taking this approach would certainly inspire me to come up with ways to cut back expenses. Perhaps I will move to an area with an extremely low cost of living. Perhaps I should do any world traveling now while I have a steady income.

It’s not all bad. Once you’ve retired, you don’t have the “expense” of saving aggressively for retirement, so more of your income will be available for your expenses.

Retirement – How Much You’ll Really Need [Yahoo Finance/Money Magazine]

Updated December 20, 2011 and originally published November 27, 2007. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 17 comments… read them below or add one }

avatar jesse

I don’t understand this. Do they mean per year you expect to live or total, assuming interest will still compound and give you enough to live off of yearly?

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avatar Luke Landes ♦127,386 (Platinum)

Jesse: The 80% rule of thumb refers to the ratio of annual income during retirement to annual income pre-retirement. The proposal is to start your planning by thinking about your yearly expenses rather than income.

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avatar jesse

I got that part but say I made $80k per year right now and that is my max salary rate. Say I spend $70k of my salary per year, with $10k going towards my retirement.

Would my *entire* retirement amount be $70k or so, which I am to live on from 65-90ish? (Ambitious, aren’t I?) Or is it $70k per year for each of those 15 years I’m going to be living off of it? (Meaning $1,050,000 – that can’t be right, right?!)

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avatar Mrs. Micah

What Flexo said is that it’s “annual” income during retirement. So you’d want to plan to have $70k each year.

Which would make the $million+ correct if you live 15 years and don’t have health problems which dramatically increase your expenses.

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avatar jesse

Oh man. By using those calculations, I am very very behind! Thanks for clarifying!

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avatar plonkee

I think the typical rule of thumb is that you want a lump sum that’s at least 25 times the size of your annual expenses (so that you can account for inflation).

So that would mean that you’d need about $1.75 million for retirement.

It might be as well to cut down on expenses.

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avatar Luke Landes ♦127,386 (Platinum)

Plonkee: That’s a separate rule of thumb based on a 4% “safe withdrawal rate.” Financial planners say that if you want to live on $100,000 income in your first year, and adjust that amount for inflation each year, you need $2.5 million (25 × $100,000) at the onset of retirement. The assumptions here are inflation at a moderate rate, your investments are all stocks, and that you want to preserve your capital (die with your original $2.5 million adjusted for inflation).

Most likely, when you enter retirement, your investments will not be 100% stocks. You’ll probably want to have some bonds in there to lower your risk. If you use target retirement funds, then that re-allocation happens automatically for you. If that’s the case, you may need to withdraw a lower percentage in order to preserve your capital. A lower withdrawal rate also means you’ll need more invested at the onset of retirement to live on an annual (hypothetical) $100,000.

All the more reason to work on reducing your expenses in retirement.

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avatar jim

I think rules of thumb are always a little tricky, my thumb isn’t the same as your thumb. :)

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avatar Luke Landes ♦127,386 (Platinum)

Jim: Some of us are definitely “thumber” than others. :-)

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avatar eze

Don’t forget to add the expense of paying for health insurance. That can be crazy expensive, but easily overlooked if your employer is currently paying for that.

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avatar JD

Flexo writes:

“Taking this approach would certainly inspire me to come up with ways to cut back expenses. Perhaps I will move to an area with an extremely low cost of living.”

Why not just move to the ghetto? Or how about Somalia? I mean really, you’re fairly young and you’re already thinking about living like a pauper at retirment?? Why not just spend retirement living in a little shack in Oklahoma and eating nothing but beans and rice? You won’t need much money, you’ll save a ton and you’ll probably feel great about not spending money foolishly like all those retirees who spend their days golfing, sailing, and strolling around nice beach towns. What fools – enjoying life, how bizarre.

Flexo says:

“Perhaps I should do any world traveling now while I have a steady income.”

Really good, so first I guess you forgot about the magic of compounding interest? I don’t know how considering you probably talk about it like its some little known super secret. If you want to travel the world now then do it! Are you actually planning out your leisure for the next 40 years telling yourself that you should do this now and that other thing than?? I travel when I want, I buy the toys that I want, and I thoroughly enjoy life instead of letting miserable miserly ways control me. Yet I still somehow managed to save over $300k after being out of college only 5 years. Crazy. PF bloggers would look at my spending and think I’m just another one of those crazy Americans living beyond my means, then they’d go back to their Ramen dinner proud of themselves for not spending $50 at the restaurant like the rest of their peers who are having the time of their lives.

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avatar Luke Landes ♦127,386 (Platinum)

JD: I am a strong supporter of enjoying life to its fullest and NOT socking *every possible penny* away for the future. I *never* said anything about living like a pauper! You’re taking the idea of reducing expenses in retirement to the extreme, which is *not* what I imagine.

There is no way anyone can classify me as a miser — just look at my monthly spending reports — and I don’t know why you would lump “all PF bloggers” as if they all have the same thoughts about everything.

I had Ramen during my college years, and I’m not planning on going back that that. I regularly eat out, spending more than $50 (for two, usually). I’m not sure that this spending makes my life wonderful; it sometimes gives me pleasure, but fleeting.

Just because someone condones being sensible about retirement does NOT mean they don’t have to enjoy life to the fullest now.

Your comment about the magic of compound interest confounds me. It’s not magic, it’s math, first of all; second of all, compound interest is for savings accounts. If most of your money is in stocks, and you reinvest your returns, then you have to talk about compound investment returns which are not as clear-cut or predictable as compound interest on savings.

I don’t know where you got that I “forgot” about compound interest.

Read more of Consumerism Commentary — you will see that I take a balanced approach, not a miserly approach, to saving, investing and spending.

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avatar vh

Interesting. In a moment of deep loathing for my job, yesterday evening I calculated a) what I spend from my net income to support myself in my present home, b) what gross income I would need to create that amount, net (added 30% for taxes), c) whether my current Social Security “entitlement” plus 4% of my present retirement savings would yield the amount needed to retire, right now, without moving to a cornfield in Iowa, and d) whether my projected Social Security at 66 plus 4% of my projected savings would support me in my present home, three & a half years from now.

The answer is that if I retire today, I will have a shortfall of $8,116, now and evermore. While I certainly can generate that much by teaching part-time, obviously my earnings will fall as I sink deeper into senility.

If I retire at 66, the total of Social Security and investment income will come to $16 more than I will need to live (assuming 3% inflation p.a., a dangerously optimistic guess) in my present paid-off home. That’s sixteen bucks.

When you’re already living frugally and your mortgage is paid off, really…there aren’t many ways you CAN cut your expenses, other than, as Flexo suggests, moving to the Third World and living on beans and rice.

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avatar UH2L

I started saving at age 26, (should have started a year earlier for the boom in 1997), and I’ve been saving for 10 years having put about $11K per year in my 401K and $2000 in a Roth (once). If I continue investing $12K per year into my 401K with a Personal Rate of Return of 12%, I can retire at age 57 taking out $113 K per year, if I can keep going at 15% PRR, I can retire at age 53 or so, taking out taking out $93 K per year.

That’s based on being able to earn 5% fixed interest on $3 million in the account as a perpetuity so that I wouldn’t reduce any principal. Of course I could dig into the principal a little bit and be fine. And if I put some money in more adventurous investments, I could draw more. Using the 4% rule, with $3M, I could take out $120,000 per year.

What’s really important is the rate of return you can earn from your 401K, and starting to save early. So this young man can hit his target and retire early. Work is overrated anyway. :-)

I also think inflation should be taken into account, not sure if that’s captured above. Based on that, $93K at age 53 is worth about $57K per year in today’s dollars. $113K at age 57 is worth about $61K per year in today’s dollars. I currently spend about $52K per year for expenses but expect that to go a bit higher. Note thought that I didn’t even take into account Social Security or the bit of pension I’ll be getting from my former employer.

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avatar Frugal Momma

Interesting discussion. I keep reading and hearing the different rules of thumbs on this. We are trying to maximize our retirement savings (in our late 30s) and currently only have $110k saved in retirement accounts.

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avatar George

JD: If you’ve saved $300k in the first five years after college while still being able to spend money and buy the things you like, then more power to you.

Unless you had a huge windfall, you’ve obviously got an income that’s way above average, and good on you for that. Your situation is definitely not “normal” – the average income is about $45,000 per year pre-tax.

The idea of planning for retirement income based on your current expenses makes much more sense than planning based on your current income. If you earn $100k but only spend $30k, then it stands to reason that you should only need about $30k each year after you retire, not $80k as many planners would suggest.

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avatar fathersez

This “rule of thumb” has thrown up an interesting debate.

If I may suggest, put countries like India, Philipines, Thailand, Vietnam and Malaysia as options for places to retire to. Especially if your RoT says you cannot retire with the costs your home country.

These places are not quite as “frightening” as Somalia or the ghettos and you should be able to have plenty of golfing and beach strolls.

Medical costs are also much cheaper.

It’s an option, that I think we should not completely ignore.

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