Testing The 70% Rule In Retirement
IS A CERTAIN PERCENTAGE RIGHT FOR YOU?
A key issue for anyone approaching retirement is the amount of money you will need to assure that you can keep the basic bills paid. Determining that number is crucial to your financial future but we too often rely on easy formulas and generalizations to make these kinds of decisions that require more careful analysis.
A good place to start the process of determining your retirement expenses is to take a look at your current budget (I'm assuming that you have one, if not please use our Income/Expense planner.) Some expenses will follow you into retirement and be close to the amounts that you now spend. Your insurances, utilities and debts will not change dramatically once you leave the workplace. Others could be significantly different such as gasoline consumption, clothing needs and travel costs. It is important that you spend time making serious assessments of these numbers and developing a written spending plan that reflects the new situation.
But that's not what most of us do.
Instead we look for the easy "rule of thumb" and the number most prevalent in this discussion is 70%.
THE 70% RULE
For years the conventional wisdom has embraced this number at the best guideline for predicting your future cost-of-living. It states that you calculate your current income and assume that your expenses will drop to 70% of that level once you retire. Instead of accepting the number at face value you should see if it really measures up to your circumstances and your goals. This is no time for a one size fits all solution. You need to construct your own analysis and here are some concepts to consider:
1. HOW IS THE NUMBER CALCULATED
Is the number 70% of gross or 70% of net pay? Remember that we can only spend the net so we always consider just your take-home pay. It is obvious that you'll not be paying payroll taxes and federal income tax on earned income in retirement, but may still have a tax bill if you are withdrawing money from a qualified retirement plan. And it is true that you won't need to be making retirement plan contributions but if you've always had these items deducted from your check then you've built a lifestyle around that take-home number. My advice is that you consider the 70% to be after taxes, SSI and 401(k) contributions.
2. WHICH EXPENSES WILL REMAIN THE SAME?
Go through your current budget and determine those entries that will not change significantly when you retire. Homeowners and car insurance, life insurance, mortgage payments, gifts, and home maintenance are just some of the expenses that probably won't differ from your current spending. Next, look to see which expenses can be reduced, especially those relating to debt payments. Reducing debt can be one of your best moves in achieving retirement security. See our previous blog Breaking The Chains of Debt in Retirement.
3. WHICH EXPENSES WILL CHANGE MODESTLY?
Some expenses will change only slightly. Utility usage, gasoline costs, car maintenance and food consumption will shift depending on such things as the distance of your commute and whether you brown-bagged lunch on a daily basis.
4. WHICH EXPENSES WILL CHANGE SIGNFICANTLY?
Here is where the 70% rule faces its greatest test. Changes in post-retirement expenses need to be examined according to which phase we are considering: younger retirement years or later. When you are in your 60s and 70s you'll probably want to travel and take on other activities that an 8 to 5 workday never allowed. You may retire to an area that is not near your family and you'll want to visit them regularly. All of these circumstances can add up to an increase in your cash outlay in your early retirement years. As you become older you may not keep up that lifestyle pace, but you could face greatly inflated costs for healthcare, long-term care and other aging issues.
The point is that 70% is a rule-of-thumb and not a rule. It is a good starting point from which to base your budget planning, but you need to incorporate your unique needs, goals and circumstances into the equation. Have a serious discussion with your spouse about how you envision retirement and those issues that could arise. Then plug in your own number that is 100% you and not 70% of everyone else.
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