Reconsidering the 80% of Pre-Retirement Income Rule

Pick up a standard retirement reference or work with a traditional planner, and you’ll be told that a retirement plan has to save enough to spend 80% of pre-retirement income in retirement. I’ve criticized that a number of different ways in Retirement Watch and in my books. Christine Benz of Morningstar takes up that argument in an article for Morningstar’s Retirement Readiness Week. Longtime readers of Retirement Watch know the fallacies of the 80% rule. They also know that my advice, and now Benz’s, is to create a customized retirement spending plan. Different people will spent different amount, even if they had the same pre-retirement incomes. You also should plan for spending to change over time. You’re likely to spend more in the first few years of retirement, and then cut back spending and activities for a period of time. Then, you’re likely to spend more in the last few years because of medical expenses and long-term care.

Does that mean the 80% rule is just a plot by the financial-services industry to get people to sock more away than they actually need to, thereby increasing the assets on which they can charge fees? Not necessarily. After all, health-care costs have the potential to swing substantially higher during retirement than they were when a person was younger, so a conservative retiree might use a rate even higher than 80% for planning purposes. People with lower incomes before retirement should, by and large, also employ a higher income-replacement rate than higher-income workers. At the same time, very high-income earners will want to plan for a replacement rate that’s well above 80%, for reasons I’ll outline in a moment.

The fact is, any “rule of thumb,” like the 80% rule for income-replacement, is a blunt instrument–a reasonable starting point, but one that can be refined with consideration of your personal circumstances. A useful starting point, especially if you’re getting close to retirement, is to prepare an in-retirement budget. Here are some of the key swing factors to bear in mind when deciding how to set your own income-replacement rate.