The Rising Cost of Retirement

The standard retirement planning advice is to plan on spending 65% to 85% of your pre-retirement income each year of retirement. Unfortunately, that is a fallacy. Following that advice could diminish your retirement.

Proof is in the latest Retirement Replacement Ratio Study, sponsored by Aon, a financial services company, and conducted by professors at Georgia State University.  The study has been conducted periodically since 1988. It estimates the percentage of pre-retirement income that is spent in retirement. That percentage is known as the replacement ratio.

One consistent conclusion from the studies is that there is not one replacement ratio that applies to everyone. Instead, replacement ratios depend on one’s income. The higher the pre-retirement income was, the higher the replacement ratio.

Another conclusion is that the replacement ratio has been rising over time. The increase usually is two percentage points to five percentage points every couple of years. This might be because tax cuts get retirees used to spending more money. In addition, the general prosperity and high investment returns of the late 1990s might have encouraged more spending.

Higher retirement spending, of course, means that higher pre-retirement saving is required to meet retirement goals.

The survey uses national data to make estimates, and the replacement ratio is only an estimate. It doesn’t make adjustments based on differences in local costs or individual spending choices. That is why I have long maintained that you should ignore estimates of average replacement ratios. Instead, determine the actual spending you anticipate for retirement. Using an estimate takes the risk that you will significantly understate or overstate your saving needs.