In my post on why the save 10% of your income for retirement rule is stupid I mentioned that expecting you’ll need 80% (or 90% or any other %…) of your pre-retirement income in retirement is stupid as well. How much income you’ll need in retirement is one of the major variables in calculating what you should save for retirement, so it’s important to use the most accurate estimate you can. Relying on a percentage rule of thumb is likely to steer you in the wrong direction for several reasons. Here are a few.
Housing
Do you plan on downsizing in retirement? Or maybe you’re thinking about upgrading. Planning to move? That’s going to change more than just your housing costs. If you’re going to be renting or still paying a mortgage in retirement, you’ll need to figure that in as well.
Consider maintenance costs as well. If you’re a handyman now and do most of your own repairs, how long will you be able to keep that up in retirement? Eventually, your physical abilities are likely to become limited and then you’ll need to hire others to do those repairs.
You can’t plan for every possible variable in your housing costs, but these are the kinds of things you need to consider when figuring out how much income you’ll need in retirement. Housing is the highest cost for most people, so it’s even more important you get this one as accurate as you can.
Transportation/Travel
Have you thought about how your transportation and travel costs might change in retirement? I’m guessing they’re probably not going to mirror your pre-retirement spending. The lack of a commute and the desire to travel more may offset each other for some people but not for most. This one might be difficult to figure out all at once, but if you take each aspect at a time you can come up with a reasonable estimate.
Food
Will you be more likely to eat out in retirement, or do you want to improve your culinary skills and cook more at home? You’ll have an excellent opportunity to lower your food costs in retirement by cooking more from scratch, but many retirees look to eating out as a way to engage in social life and get out of the house. Depending on your preferences, skills, and plans, this could be another area that you’ll need to consider carefully.
Health
During retirement, you’re going to be shouldering more of your health insurance expenses. Your health will also be at a higher risk of declining as you age, so you’ll have to expect more health costs overall. This is one area where many retirees experience a large increase in spending – especially as retirement goes on.
Income Taxes
Depending on your personal situation and how you decided to save for retirement, your taxes in retirement could look quite different than before retirement. This is especially true if the income you’ll need in retirement is very different from your pre-retirement income. There are a number of variables that affect income taxes and they change from person to person. Assuming you can count on an average to help you might the right decision for your retirement is foolish.
Savings
This is at least one area where the percentage rules directly account for some changes in retirement. But there’s still a problem. Maybe you waited until 10 years before retirement and had to save 30%, 40%, or 50% of your income to catch up. That’s going to drastically change once you enter retirement, so you need to look at your unique circumstances. Or maybe you hit a windfall sometime in your life and haven’t been saving anything for retirement. Following one of these rules of thumb won’t work for your situation either.
It doesn’t matter if you don’t fit into one of the examples I shared above. The point is that your situation is different and unique to you, and you need to plan accordingly.
So How Should You Figure Out How Much Income You’ll Need in Retirement?
I think it should be clear by now that the only prudent way to figure out your retirement income needs is to carefully consider your own situation by looking at your circumstances and expenses alongside your goals. When I was creating my free retirement calculator, I wrote an article specifically designed to help you start thinking about how much income you’ll need in retirement based on your situation. It doesn’t cover every possibility, but it will help you get started.
My goal in pointing out how stupid these rules of thumb are is not to make things difficult for you or to make fun of others who give this kind of advice. I want you to see that your financial decisions involve factors that are unique to you. You shouldn’t risk making a wrong decision because you followed an easy rule of thumb. Take the time to really think about your situation, learn what you need to know so you can make a smart choice, and use that knowledge to manage your money well.
photo credit: (Hans Gerwitz on Flickr)
This article was included in the Best of Money Carnival.
This article was included in the Carnival of Financial Planning.
