Why the 80% Retirement Rule Is Bullshit
Retirement planning can be tricky, so reducing it to a couple of simple rules of thumb is reassuring. One retirement “rule” that is often mentioned is the “80% rule” (the exact percentage varies slightly depending on who you talk to): it assumes that you need 80% of your pre-retirement income in order to maintain your current image. life.
This “rule” makes a lot of people sweat when they review their IRAs and 401(k) plans, using another rule of thumb: the 4% safe withdrawal rule , which says you should spend 4% of your income in your first year of retirement, then Adjust withdrawals in subsequent years to reflect inflation. The idea behind this rule is to keep your savings for 30-50 years so you don’t run out of money, and it often comes down to just relying on 4% of your retirement savings for income.
This is where the pot comes from: if you have $200,000 in an IRA, 4% is only $8,000. If you’re currently making $50,000 a year and think you need $40,000 to make it to retirement, it’s easy to panic. But don’t do it, because the 80% rule is, in a word, bullshit.
What does the 80% rule imply?
First of all, the 80% rule is based on a lot of assumptions, many of which no longer apply to many people. This “rule” has been around for decades and often assumes that you have significant travel and professional expenses (appropriate clothing, etc.) and that many of us are tied to high cost of living (HCOL) areas due to our workplace. But in a world where remote work and business attire are becoming the norm, that may not be the case for you.
The rule also makes a lot of assumptions about your finances. For example, it is commonly assumed that you are putting your money into savings at the national average rate (a little over 3% at the time of this writing), but is that really the case? Or are you saving a lot less or a lot more? Another assumption the rule makes is that you’ll be living the exact same lifestyle when you retire – that you’re not going to move or change your spending in any way. And the rule generally assumes that you will no longer have a mortgage, but this is actually becoming less and less common these days.
The fact is that pension costs can be very dynamic. While many people increase their spending in the early years of traveling and acquiring new hobbies, as they get older they tend to cut back on such spending. At the same time, health care costs can rise with age, so our costs can rise with it. It’s not that your lifestyle will or won’t change; the thing is, you can’t just guess how it will be.
Math not tested
A study by Aon Consulting found that the percentage of income needed to sustain your lifestyle varies greatly and favors people with average incomes. For example, someone who makes just $20,000 a year will need 94% of that income to maintain their lifestyle in retirement, while someone who makes $90,000 will only need 78%. People earning significantly more may require a higher percentage.
The reasons for this are obvious when you think about it: low-income households save less because living expenses make up the bulk of their income. They pay less taxes, which means they get less benefit when they stop paying those taxes. And perhaps the most important reason for the 80% rule: people with low incomes have much less room to cut their spending, so they can’t make major lifestyle changes to make up for their lower income.
Focus on retirement expenses
And this is the real key: The 80% rule isn’t about your income, it’s about your expenses . And you generally have much more control over your retirement expenses than you do over your income, which is relatively fixed for most people, or at least subject to market forces and out of their direct control other than moving your investments. While most people in retirement have plenty of ways to adjust their spending, from selling a big house and moving to a cheaper area of the country to simply cutting back on travel and other luxuries.
It’s also a good idea to think about spending in other ways: when you retire, you won’t be putting all that money into retirement accounts anymore, so your savings spending could drop significantly. Your tax situation will also change drastically, although there is no guarantee that your tax burden will decrease, depending on where you receive your income after retirement.
But that’s the point: there are many variables. The 80% rule is handy when you’re drawing plans on the back of an envelope, but in real life it’s more of a recommendation than a rule. Your retirement income needs can be well below or above 80%, so it’s important to take a close look at your finances. This doesn’t mean that you shouldn’t try to save as much as possible for your golden years – it just means that you shouldn’t use an arbitrary number to decide if you’re on the right track.