Conventional wisdom says you need retirement income equal to 80% of your final salary. But there is a decent chance you could happily retire with far less.
Let’s start with reality: Most of us don’t have a well-honed financial plan in which we set out to amass a specific sum and quit the workforce only when we hit our target. Instead, we save what we can and then make do.
If that means retiring with less than 80%, I wouldn’t be overly concerned. Consider a 2014 survey of recent retirees by Baltimore’s T. Rowe Price Group.
The 1,507 participants, who had a median net worth of $473,000, were living on an average of 66% of their preretirement income. Yet 57% said they were living as well or better than when they were working, and 85% agreed with this statement: “I don’t need to spend as much as I did before I retired to be satisfied.”
The 80% replacement ratio assumes you can get by on less than your final salary because you no longer are saving 10% a year or so toward retirement. You also are no longer making an employee’s 7.65% payroll-tax contribution to Social Security and Medicare.
In addition, your federal income-tax bill should go down. Those 65 and older can claim a higher standard deduction or, if they are itemizing, can often deduct unreimbursed medical and dental expenses in excess of 7.5% of income, versus 10% for those who are younger. On top of that, a significant portion of your income will likely come from Social Security benefits, which are partially or entirely tax-free.
Set against these savings is one cost that could rise sharply: health-care expenses. This is a wild card, in part because much depends on whether you end up in a nursing home.
All this seems reasonable as far as it goes—but I don’t believe it goes far enough. While some retirees might need 80% of their preretirement income, here are three reasons you may be comfortable with much less.
Your children are off the family payroll.
According to the Agriculture Department, it costs $245,000 for a middle-income family to raise a child through age 17. College might add another $100,000 or $200,000, and possibly more, depending on whether your teenager goes to a state or private school. Often, the tab doesn’t end there, as parents subsidize their adult children’s initial years in the workforce.
What happens when those bills are over? Some experts think the parents’ cost of living falls sharply, which means they don’t need nearly so much retirement income. Anthony Webb, a senior research economist at Boston College’s Center for Retirement Research, disagrees.
“I don’t think it equates to what people do in the real world,” he argues. “When the kids leave home, instead of consuming less and saving more, the parents spend more. They likely travel more and go to nicer restaurants.”
It is a shame empty-nesters aren’t seizing the opportunity to save more. But there also is cause for optimism: If the money is getting lavished on travel and eating out, it suggests the parents have a fair amount of financial wiggle room—and they could easily cut expenses if they later find themselves without enough retirement income.
You were saving more than 10%.
In 2014, Americans saved just 4.8% of their disposable personal income, according to the Bureau of Economic Analysis. But while many Americans save pitifully little, I meet plenty of folks who regularly sock away 20% of their income, and even more once they count any matching employer contribution to their 401(k) plan.
That brings us to one of the great financial ironies: The more you save, the less you need for retirement. If you sock away just 10% of your income, you might indeed require 80% of your final salary to retire in comfort. But if you save 25%, you could sustain your current lifestyle with perhaps 65%.
Your mortgage is paid off.
More people are carrying mortgage debt into retirement. The Federal Reserve’s 2013 Survey of Consumer Finances found that 42% of households headed by someone age 65 to 74 have debt that is secured by their home, up from 32% in 2004.
Many seniors, however, seem to get this debt paid off in their initial retirement years. Among households headed by someone age 75 and older, less than 20% have loans secured by their house.
“If you have your mortgage paid off, it might take down the income you need by 10% or 15%,” says Denver financial adviser Charles Farrell, author of “Your Money Ratios.” “If you have low fixed costs, you could probably retire with a lot less than 80%. You might be comfortable at 50% or 60%.”
Jonathan Clements is the author of the “Jonathan Clements Money Guide 2015.” Email: ClementsMoney@gmail.com