A classic retirement planning rule states that you should retire on 80% of the income you earned in your last year of work. Is this old axiom still true, or does it need reconsidering? Some new research suggests that retirees may not need that much annual income to keep up their standard of living.
The 80% rule is really just a guideline. It refers to 80% of a retiree’s final yearly gross income, rather than his or her net pay. The difference between gross income and wages after withholdings and taxes is significant to say the least.1
The major financial challenge for the new retiree is how to replace his or her paycheck, not his or her gross income. So concluded Texas Tech University professor Michael Finke, who analyzed the 80% rule last year and published his conclusions in Research, a magazine for financial services industry professionals. Finke concluded that the typical retiree could probably sustain their lifestyle with no more than 77% of an end salary, or 60% of his or her average annual lifetime income.1
Retirees need to determine the expenses that will diminish in retirement. Some examples include:
- You will no longer be deferring part of your income to retirement savings. This could range from as little as 5% up to 25% of your income.
- Contributions to Social Security and Medicare.
- Cost of your daily commute to work and the expenses that accompany it.
- Most people retire into a lower income tax bracket.
- You will no longer need to purchase work attire and incur the associated dry-cleaning expenses.
New retirees may not necessarily find themselves living on less. The retirement experience differs for everyone, and so does retiree personal spending. A timeline of typical retiree spending resembles a “smile.” A 2013 study from investment research firm Morningstar noted that a retiree household’s inflation-adjusted spending usually dips at the start of retirement, bottoms out in the middle of the retirement experience, and then increases toward the very end.2
A retirement budget is a very good idea. There will be some out-of-budget costs, of course, ranging from the pleasant to the unpleasant. Those financial exceptions aside, abiding by a monthly budget (with or without the use of free online tools) may help you to rein in any questionable spending.
Any retirement income strategy should be personalized. Your own strategy should be based on an accurate, detailed assessment of your income needs and your available income resources. That information will help you discern just how much income you will need when retired.
Julie Newcomb, a Certified Financial Planner™ in Orange County, CA, specializes in financial planning for women. As a wife, mom and business owner, Julie understands the pressures and challenges most women feel on a daily basis as they juggle many important priorities. Julie’s favorite thing about her job is the ability to give women peace of mind when they entrust her with their finances. To learn more about Julie Newcomb Financial, go to julienewcomb.com.
1 – marketwatch.com/story/you-may-need-less-retirement-income-than-you-think-2015-11-30 [12/24/15]
2 – money.cnn.com/2015/12/02/retirement/retirement-income/ [12/2/15]