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Two Takes on the Magic Retirement Number

Posted By timparker On 04/09/2012 @ 2:11 pm In Personal Finance | 17 Comments

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 [3] 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 [4] 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.


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[3] 80% of their gross income: http://money.cnn.com/2009/10/08/pf/expert/retirement_incom.moneymag/index.htm

[4] Forbes: http://www.forbes.com/sites/janetnovack/2012/02/14/why-you-might-need-less-retirement-income-than-you-think/

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