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How Much of Your Income Do You Need to Replace in Retirement?

When planning for retirement, start with the understanding that life is not constant. Your financial obligations before retirement are likely to be very different, and your income and expenses will change during those years.

Retirement is dynamic

The assumption that retirement expenses will remain constant is inaccurate. Although certain essential living costs may stay the same, and some costs—such as work expenses, taxes, and mortgage payments—may decline, how retirees choose to spend their time during different retirement phases can require more or less income.

For example, retirees often spend more in their early retirement years on things such as travel and entertainment, and may need 100 percent or more of their income to live the lifestyle they want. The middle retirement years may be centered closer to home, with more evenings in than dinners out, and expenses may decline. Costs in later retirement years often depend on health and longevity, with medical and long-term care costs accounting for a larger percentage of income. Retirement spending is not a straight line.

Research has shown that while some retirees need more than 80 percent of their previous income during retirement, others can manage on around 50 percent. Those percentages can fluctuate over the course of retirement. It is highly individual.

The percentage of income you need to replace in retirement to cover projected expenses also depends on how much discretionary income you have. If money is tight and you use most of your income for essentials, you will probably need to replace a higher percentage of that income in retirement simply to get by.

If, on the other hand, you have had substantial discretionary income, you may have more freedom to decide how to cut back during retirement and therefore replace a lower percentage.

Preparing a financial plan will increase your confidence

The key to confidence is planning ahead. Recent research from the Employee Benefit Research Institute (EBRI) found that only 42 percent of people calculate how much they need to save to live comfortably in retirement. That is where uncertainty comes in. On the positive side, Schwab's 2019 Modern Wealth Survey found that 56 percent of planners felt "very confident" they would reach their financial goals, compared with only 17 percent of nonplanners.

To truly understand how much retirement income you will need, dig into the details. Enter some numbers into a calculator or spreadsheet. Consider speaking with a financial planner who can help determine how much you can spend, analyze how inflation and taxes factor in, and develop hypothetical scenarios based on your personal situation.

Meanwhile, pay down debt, consider reducing fixed costs such as a mortgage, and even experiment with living below your means. That way, you will not only save more now while you have your full income but also become accustomed to living on less. This may be the best way to understand personally what percentage of your income will be enough to live comfortably and confidently through every phase of retirement.

The information provided here is for general informational purposes only and is not intended as a substitute for specific, individualized tax, legal, or investment planning advice. When you consider it necessary or appropriate, consult our specialists at Partners for Life.