Personal Finance 

Two Takes on the Magic Retirement Number

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You have surely heard about “the magic number.” This is the amount of money you need to save in order to live a financially comfortable life once you reach retirement age. With many soon to be retirees finding that their 401(k) is coming up short, the magic number is becoming much more than just a guideline.

The current workforce is demanding a more scientific approach to finding the magic number but even the experts don’t agree. Some financial planners believe in the traditional guideline of replacing 80% of pre-retirement earnings while others have a different idea.

Traditional Wisdom

Aon Consulting and Georgia State University produced the 80% rule. By studying data from the Bureau of Labor Statistics as well as many other sources that reveal how much money people spend during retirement, they concluded that most retirees need roughly 80% of their gross income in order to sustain them after retirement.

Why not 100%? First, retirees pay less in taxes since their income usually falls once they retire. Next, retirees don’t pay social security and payroll taxes and for many, additional tax deductions are available. Finally, most retirees stop contributing to retirement accounts taking away yet another expense.

But the one size fits all 80% figure doesn’t work for everybody. In general, the more you make, the higher the 80% figures goes. If you made $250,000 before retirement, you may need 88% or more.

Another Take

But not everybody believes that the 80% is accurate. In fact, some believe that the amount needed is less much less. Forbes reports that a new study reveals that household spending declines rapidly as people age. By the time a person reaches 75 years old, spending  declines 19%. Once the person reaches 85, they see a 34% decline compared to when they were 65 and by age 98, spending is more than cut in half at 52%.

Although medical expenses rise as people age, the decline in spending more than makes up for the rise in medical expenses according to the study’s authors. The study concludes that you may need 80% at the beginning of retirement but that number will dramatically drop as you get older making the 80% rule too high.

What’s the Answer?

Luckily, the rules of responsible money management can help us to cut through the controversy. The best way to be ready for retirement is to contribute the maximum amount to your 401(k) that is matched by you company, have an IRA in addition to your company sponsored retirement account, and save as much as you can in a non-retirement brokerage account.

Since most large scale expenses that could result from unforeseen events such as an illness or injury can be paid for through your retirement accounts without an IRS penalty, the idea that retirement funds are cut off from us should a true need arise, is largely inaccurate.

Finally, financial planners have access to sophisticated software that will calculate your magic number based on your detailed responses to a large amount of questions. The software produces long and detailed reports that forecast your needs as you age. Even if you don’t have a lot of confidence in a financial planner’s opinion, paying for the detailed report is well worth the expense.

{ 17 comments, please add your thoughts now! }

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17 Responses to “Two Takes on the Magic Retirement Number”

  1. Matt says:

    I guess it depends on what you want to do when you retire, if you want to travel a lot you’d need over 100%.

    • Even with that, it depends on the type of travel you want to do. Sure, going to the big touristy places will cost a lot, but there are much cheaper options. My in-laws take 2-3 week trips to exotic places for $1K-$2K each. Groups like Friendly Planet have some great options for cheaper international travel.

      • Matt says:

        Yeah but not everyone wants to take a vacation in a jungle or exotic cheap place. Most people want to go to beaches, resorts, monuments, and other touristy things.

  2. Courtney says:

    We plan to have 100% independent of social security. Then we’re pretty much covered for anything that could happen.

  3. Ray says:

    I thinks its a hard sell to say that your household spending is a more significant factor than health care spending when you get older. Especially if you lived frugally most of your life.

    It really is different for everyone, if your lucky enough to have great health then sure you healthcare costs are low. Conversely a person who has many health issues will spend more time in the hospital than on vacation.

    • Shirley says:

      I agree with Ray and feel that there is no way to know what your health spending could be. Even with a lifetime of good health and a very good health insurance plan, a catastrophic illness or accident could wipe out your savings.

  4. Martha says:

    @Matt; you’d have to travel for long periods of time to significantly change that number. I wouldn’t expect to take multiple month long excursions when I retire. If you want to travel that much it may be worth it to look into renting a place as a hub and take smaller day/weekend trips from there (think small town in England to allow for trips around Europe).

  5. Matt says:

    That’s a good idea to rent a hub, it seems like plane tickets and hotel rooms and meals would eat away at your savings quickly.

    • Scott says:

      When you retire you have the flexibility to travel at off-peak times and get much better travel deals and rates. Not saying it will be cheap, but it can definitely be a lot cheaper to travel when you retire than it is now (assuming you’re not retired now…).

  6. Scott says:

    Why are people questioning the 80% rule now? Because they can’t meet 80%? Do they want to spend more money now and want to make sure they aren’t screwing themselves down the road? If someone walks in and tells me, hey, good news – you only need to replace 70% instead of 80% of your income in retirement, does that mean I’m going to go spend that 10% now? No, I’ll still save it for retirement. Maybe it’s just me, but it sort of sounds like the people clammoring for a different approach to the magic number may be trying to justify their current bad spending habits.

  7. Shirley says:

    “…you may need 80% at the beginning of retirement but that number will dramatically drop as you get older making the 80% rule too high.”

    If you end up needing personal care assistance, you will need a lot more than 80%.

  8. Allie says:

    I have recently retired and we have always lived frugally, paying our first house off in 6 years and second one off in 10 years, put our kids thru college and just paid cash for our new retirement home and sold the old house in 14 days and giving that money to the kids so they can eventually pay off their homes early. We want for nothing. My husband has been diagnosed with dementia and we can live on our social security easily so far.

  9. Tom says:

    Some people live below their means. It would be better to derive a percentage from your current expenses.

  10. timparker says:

    The problem, according to some, is that taking a percentage of your current income doesn’t take in to account how your needs will change in the future. I would also add that if the price of health care continues to rise, that will substantially change the magic number calculations.

  11. govenar says:

    I’m not sure about “the more you make, the higher the 80% figures goes”. I guess the idea is that if you’re spending a ton of money on luxury items when you’re young, you’ll want to maintain the same expensive lifestyle when you retire? But if you’re making millions of dollars per year, it’s pretty easy to live on a small percentage of that.

  12. Obviously it is going to vary for each individual, but for those following this blog, the 80% rule is most likely way more than enough. That 80% is based on your income, not your expenses. Most of us that care enough about our finances to follow this blog are dumping lots of money into 401Ks, IRAs, and various other investments. Ideally, when we retire, we won’t need to continue increasing our investments, which will significantly reduce our expenses. Additionally, most will (again ideally) have their mortgages paid in full.

  13. timparker says:

    That’s a whole lot of ideallies, Seth. 🙂

    I like to make things as simple as possible. If I save as much as I can, I retain the flexibility to do with that money what I want or need. If I get to retirement and it appears that I have a lot of extra money, it’s a lot easier to spend my saved funds that try to make up for a shortfall. The more the better.

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