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How Much Income Do You Actually Need in Retirement?

Retirement Income

Retiree incomes are falling short in 47 states…at least that’s the conclusion of a new Bankrate study. But with America’s general lack of retirement preparedness, that probably comes as no surprise, right?

Bankrate analyzed the US Census Bureau’s most recent American Community Survey by comparing household income of folks age 65+ with incomes of those age 45-64. Most financial advisors believe you need at least 70% of your pre-retirement income in retirement (see my comments below) so Bankrate benchmarked the Census Bureau results against that.

Here are the highest and lowest replacement percentages, Oregon and Washington, and the national average (full table here):

 State  Median household income, age 45-64 Median household income, age 65+ Income replaced in retirement
 Hawaii $80,106 $58,150 72.6%
 Washington $73,740 $44,104 59.8%
 Massachusetts  $86,036 $41,489 48.2%
 Nationwide $65,018 $39,186 60.3%

Source: U.S. Census Bureau 2014 American Community Survey

So that's interesting, but how much do you actually need for financial independence?

Rules of thumb are short cuts that can save us time. They're fine for basic everyday encounters, but you'd never want to risk 20-30 years of your later life on some rule of thumb, such as the 70% replacement ratio recommended by many advisors. That's backwards. Instead, figure out what you'll actually need and how you'll pay for it.

If you have big plans for your retirement, you may need 90% to 100% or more of your pre-retirement income, at least during the "go-go" years. If your tastes are modest and your idea of a great retirement is simply relaxed time with friends and family, maybe you can recreate your retirement "paycheck' with only 60%. If you have a $200,000 household income before retirement, the percentage you need to replace may be much lower than, say, someone who earns $40,000 and needs to replace all of it. 

There are as many retirement spending plans as there are people and your spending should be based on your particular needs and priorities, not some arbitrary percentage. What do you want to do during your financial independence? What are your lifestyle expectations? What if you draw a wildcard with health or long term care? It takes actual retirement planning and running projections to know what you'll need and how you'll pay for it.

Another reason the 70% rule of thumb is arbitrary is your spending during retirement will likely vary during three stages:

  1. The "go-go" years. These are the earlier, more active years of financial independence. You might be taking those trips that you've put off for years, tackling deferred hobbies, or starting a business. This stage tends to cost more, sometimes a lot more.
  2. The "slow-go" years. You might settle into more of a retirement routine with less spending and activity. Expenses tend to decline accordingly.
  3. The "no-go" years. These might be considered the twilight years with far less activity than in the other stages. Basic spending tends to be considerably lower than the earlier years. But that can be (more than) offset by greater healthcare and/or long term care expenses, particularly in the final year or two of life.

Most of America is stepping into retirement woefully unprepared because folks are just "winging it" (that and they need to be saving more along the way). Don't wing it...there's too much at stake. Find an advisor who actually specializes in retirement planning and the retirement transition, someone who can help you chart a course to a purposeful and fulfilling life of financial independence.