The old income-replacement rule of thumb calls for replacing 80 percent of your annual pre-retirement income. But it's a rough estimate--and wrong for a hard times economy.
How much money will you need to live comfortably in retirement?
One way to calculate the answer is the old income-replacement rule of thumb–to retire comfortably, you must replace 80 percent of your annual pre-retirement income. But at best, this is a rough estimate. For example, it doesn’t take into account unforeseen spending needs such as higher health care expenses or a long-term care insurance policy.
At the same time, the rule doesn’t recognize that some expenses might fall or disappear entirely, such as commuting or maintaining a business wardrobe.
But most important, the income replacement method is wrong for our current hard times economy, because it puts all the focus on wealth accumulation. It doesn’t begin with the correct questions: What is the lifestyle I want? How much will I need to spend on basics? What can I afford to spend?
“The replacement ratio method is a good place to start, but it ignores major changes that can result from reduced expenses for dependent children, paying off a mortgage or downsizing major items like your home or cars,” says Steve Vernon, an actuary and president of Rest-of-Life Communications, a retirement-education concern.
“It also assumes you’ll want the same material standard of living in retirement that you had before. That ignores the possibility that you might be willing to live on less. Often, as people age, they’re less interested in material things and more interested in learning, hobbies, volunteering, and spending time with friends and family.”
A better approach in hard times is to start with a clean slate. Take the time to ascertain what foreseeable retirement expenses and balance them against the sources of income that you can count on. Check the list of key retirement expense issues to consider at RetirementRevised.