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Retirement planning can be complex, so boiling it down to a couple of simple rules of thumb is comforting. One retirement “rule” that gets tossed around a lot is the “80% rule” (the precise percentage varies a bit depending on who you’re talking to): It suggests you will need 80% of your pre-retirement income in order to maintain your current lifestyle.
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This “rule” has a lot of folks sweating as they review their IRAs and 401(k) plans using yet another rule of thumb: The 4% safe withdrawal rule that you should spend 4% of your income in your first year of retirement, then adjust withdrawals in subsequent years by the rate of inflation. The idea behind this rule is all about making your savings last 30-50 years so you don’t run out of money—and it often gets dumbed down to simply relying on taking 4% of your retirement savings as income.
This is where the sweat comes from: If you have $200,000 in an IRA, 4% is just $8,000. If you’re currently earning $50,000 a year and you think you need $40,000 to survive your retirement, it’s easy to panic. But don’t, because the 80% rule is, in a word, bullshit.
What the 80% rule assumes
First and foremost, the 80% rule is based on a lot of assumptions, many of which are no longer applicable to many folks. This “rule” has been around for decades, and often assumes that you have significant commuting and professional expenses (proper attire, etc.) and that many of us are locked to high-cost-of-living (HCOL) areas because of our jobs. But in a world where telecommuting and business casual is increasingly the norm, that may not apply to you.
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The rule also makes a lot of assumptions about your finances. For example, it typically assumes you’re putting money into savings at the average national rate (as of this writing, just over 3%)—but are you? Or are you saving a lot less—or a lot more? Another assumption the rule makes is that you’re going to maintain exactly the same lifestyle when you retire—that you’re not going to move or change your spending in any way. And the rule tends to assume you will no longer have a mortgage—but in the modern day, this is actually less and less common.
The fact is, retirement spending can be very dynamic. While many people increase their spending in the early years as they travel and take on new hobbies, as people get older, they usually cut back on that kind of spending. At the same time, healthcare costs can rise as we age, so our spending can rise with it. The point isn’t that your lifestyle will or won’t change; it’s that you can’t simply assume how it will.
The math doesn’t check out
A study conducted by Aon Consulting found that the percentage of income you need to maintain your lifestyle varies wildly, and favors folks in the mid-range of incomes. For example, someone earning just $20,000 a year would need 94% of that income to maintain their lifestyle in retirement, while someone earning $90,000 would need just 78%. Folks making significantly more than that might need a higher percentage.
The reasons behind this are obvious once you think about it: Lower-income households save less because living expenses consume a larger proportion of their income. They pay less in taxes, which means they get a smaller benefit when they stop paying those taxes. And perhaps the most important reason in regards to the 80% rule: Lower-income folks have a lot less runway to reduce their spending, so they can’t adjust their lifestyle much to compensate for lower income.
Focus on retirement spending
And that is the real key here: The 80% rule is not really about your income, it’s about your spending. And you typically have a lot more control over your spending in retirement than your income, which is relatively fixed for most people—or at least subject to market forces and outside their direct control beyond moving their investments around. Whereas most folks in retirement have many ways they can adjust their spending, from selling a large home and moving to a lower-cost area of the country to simply scaling back travel and other luxury activities.
It’s also a good idea to think about spending in other ways: Once you retire, you won’t be shoveling all that cash into retirement accounts anymore, so your spending on savings may go down significantly. Your tax situation will change drastically, as well, though there’s no guarantee your tax burden will go down, depending on where your income is coming from in retirement.
But that’s the point: There are a lot of variables. The 80% rule is handy when you’re sketching plans on the back of an envelope, but in real life, it’s more of a guideline than a rule. Your income needs in retirement may be a lot lower or higher than 80%, so a nuanced look at your finances is necessary. This doesn’t mean you shouldn’t try to save as much as is practical for your golden years—it just means you shouldn’t use an arbitrary number to decide whether you’re on track.
