As a rule of thumb, individuals should plan for an income replacement rate of 75% of their gross preretirement income in order to maintain their current lifestyle in retirement. This article discusses situations where that number makes sense, as well as circumstances where the investor might need more or less money in retirement based on consumption and saving. Additionally, based on factors such as income level and marital status, it illustrates how spending might be funded by Social Security and personal savings. Be conversant and credible on this step in the retirement planning conversation.
There’s more to planning for retirement than just saving money. It’s about knowing how that money will fund your expenses when you stop working.
It’s helpful to have a target for what you might spend in retirement. The challenge is knowing what those expenses might be if you’re many years away from retiring. One approach is to estimate your income needs in retirement as a percentage of your preretirement household income. We refer to this as an income replacement rate.
For starters, consider planning to replace around 75% of your gross preretirement income at the onset of retirement in order to maintain your current lifestyle in retirement.
Why 75%? Generally, living expenses do go down in retirement. Taxes will likely be reduced as well, especially payroll taxes when you stop working. And you won’t be saving for retirement any longer.
In the example outlined in this perspective, we assume household income of $100,000–$150,000 at retirement and a 5% spending reduction at the onset of retirement. The example also assumes that the household has been saving 8% of gross income (pretax). Keep in mind, while the income replacement rate estimates what you might need in retirement, there is no guarantee that an 8% savings rate will be sufficient to meet that need.
Estimating Your Income Replacement Rate
Many investors will fund their retirement through personal savings and Social Security benefits. Your marital status and household income are two factors that impact the amount of your Social Security benefits, your tax situation and, therefore, the total income replacement rate.