Why I Won't Need 80%
"If people do not believe that mathematics is simple, it is only because they do not realize how complicated life is."
The rule of thumb from the financial experts is that you will need to replace 80% of your pre-retirement income in order to maintain the same standard of living when you retire. I suppose that figure may be true for some people, but it clearly won't be the case for me.
The first thing to realize is that after retirement, I won't need to be saving money, so the percentage of my income that I have been saving each year won't now be needed to support my standard of living. And if you retire early, of course, it's a good bet that you had a high savings rate which enabled you to get there so soon. For me, I've been saving around 40% of my income for quite a while, so simply dropping the need to continue to save money would by itself reduce my "magic number" to 60% of pre-retirement income.
Second, after retirement I won't be paying Social Security and Medicare tax on my income because at that point, the sources of my income (i.e. interest, dividends, capital gains, and pensions) won't be considered earned income. This saves another 7.65%, and puts the magic number close to half of pre-retirement income.
Third, a drop in income to one half of my pre-retirement income means a significant reduction in my Federal and State income taxes. This further reduces the percentage of pre-retirement income needed.
Ultimately, I believe my income level at retirement is a poor proxy for my retirement needs. A better choice would be to use my consumption level at retirement. For many people, income level is unfortunately roughly equal to consumption level, so in that case, income may provide a close approximation to consumption and I believe that is probably the origin of the 80% rule of thumb.
Lastly, I would be remiss if I painted the entire story as good news. For while I believe that the required initial level of retirement income is often grossly overestimated, I also believe that the required growth of retirement income is often severely underestimated. I have compiled a number of anecdotal measures of inflation from my own personal experience and the results are not pretty.
Much of my retirement planning for the last several years reflects this reality. Most of my portfolio strategy is centered around dealing with two problems: the order of investment returns and inflation. I hope to address these issues in detail in futures posts.
5 comments:
Great looking blog template S.B.!
Your discussion got me thinking about how I compare to the 80 percent. I retired a couple of years ago at 55 and don't think I'm close to 80 %. I will review my numbers and post soon.
great blog, I am on a simliar path, just curious what is your "number" assuming no debt and house paid for, how much cash do you need in the bank? and what did you calculate your ss income to be considering your early retirement?
thanks Ken
Ken,
If I back out my mortgage payments from my current consumption, it comes out to about $40K per year. That is too definitely too low, however, as it fails to account for the fact that my employer pays virtually all of my family's health and dental insurance. The number I have generally been more comfortable with is about $55K. (Health care seems like the big wildcard in all this to me...)
I hate to reduce the magic number to a simple multiple of consumption as I feel that's oversimplified. But until I can get some more detailed posts out there about that, I'd say a rough working number for me expressed as multiple would be about 20x consumption, where I only include liquid assets. (i.e. no home equity, vehicles, children's college funds, etc)
As for Social Security income, I'm gradually working on a couple of detailed tables and should have them posted later in the week.
Thanks for posting. Glad to hear you're also on a similar path.
S.B.
I have posted my numbers if your interested. Your right...going from big savings to no savings can be a big factor.
Thanks for your Blog!
Your concern about inflation is critical, particularly for an early retiree. I am a military member and will be able to take advantage of an annual cost of living adjustment to my benefit for life. That will make all the difference in my retirement gameplan.
Lee
http://yourmilitarymoney.blogspot.com/
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