Does an 80% Replacement Rate Still Make Sense?

Do people need 80% of their income when they retire?

Texas Tech finance professor Michael Finke challenges the industry accepted 80% income replacement rule in a thoughtful piece on ThinkAdvisor.

During their working years, people generally don’t spend 100% of their income, whether saving for retirement or other reasons. Retirees generally experience post-career savings on work-related expenses, subsidized health care, lower Social Security rates and lower income brackets — plus, they don’t face education or other child-related expenses.

On the other hand, health care expenses are only likely to rise in the future. And studies show that many people spend more immediately following retirement because suddenly they have a lot more free time on their hands.

The other question is whether to calculate 80% of a retiree’s latest income, which is generally the highest of their career, or use more of a late-career average spanning several years. Many DB plans, for example, take the average of the last five years of employment.

Research indicates that a majority of people would be willing to live on 30% less income after they retire — but when asked whether they could cut 30% of their expenses, most said no. And some people, especially higher income retirees, are still saving, and are unhappy that they are required to take distributions.

Moreover, those at lower incomes stand to have a greater percentage of their pre-retirement income replaced by Social Security, while many “retirees” will continue to work in retirement for reasons other than just supplementing income. So it’s important to realize that not all income replacement will come from DC plans.

So is it time to retire the 80% rule? Prof. Finke thinks so.

Add Your Comments


  1. Brad Palmer
    Posted September 2, 2015 at 10:58 am | Permalink

    So the article says to retire 80% but doesn’t say what should replace it. My thought is 75% or 80% is fine to set a benchmark and set the stage for a good advisor to have a meaningful discussion in a personalized replacement ratio calculation.

  2. James Franken
    Posted September 2, 2015 at 11:44 am | Permalink

    This is all fine and good, but if not 80%, then what? I believe the key is in paragraph 6. People think they can cut back on expenses, but few actually do.

    Child rearing expenses are mostly gone, but may not be entirely gone. Don’t forget possible expense of caring for elderly parents. Recall, we are the sandwich generation.

    Of course not all income replacement will come from DC plans. That premise is not part of the 80% replacement design. 80% is made up of income from all sources. Social Security is a major part of this replacement percentage. One could consider Part-time income, after “full time retirement” as part of the percentage as well.

    I would ask Prof. Finke if he has put together a projection of what he will need in retirement. This could be an eye-opening experience which might help guide the search for a clinical answer.

  3. url url'>Jim Tex Frazier
    Posted September 2, 2015 at 2:51 pm | Permalink

    In 35 years of designing retirement cash flows, I rarely have used 80%. Unless I felt the client needed a reality jolt of course. 80% for most clients is just very high.

    Now 80% of take home is a real number for most middle income consumers. That can be reduced further by the amount of mortgage and loan debt payments currently being paid. The emphasis then is on having NO Debt post retirement, unless it’s for a second home or RV and the opportunity is right.

    I think a much more important number is the cash flow from invested assets percentage, that is used to determine income. I’ve never used 3 or 4%. When I started doing these in 1979 the industry was using 5% with interest rates at 8% and going higher. I used 6% then raised the percentage to 7% until 2008 when I went to a three figure system. 6% is the base rate, with 5% on the low end and 7 % as the high.

    I’ve found that using arbitrary figures will get you fired in a hurry with retirees. Remember most people hate numbers. Emphisize the lifestyle concepts they want and the numbers with take care of themselves.

    Ask them what they need monthly to live on as they do currently. Then determine on your own from pay stubs and tax returns what they actually spend month in and month out. Many consumers purposely pay more taxes and take less home to get a ten or twenty thousand dollar tax refund. Those that rely on large bonuses to live are a difficult prospect. Those that save them are the ones you want! 🙂

    The Self Employed client you want, is always over paying in advance, projected income taxes for the year ahead. Accountants routinely make sure to over fund quarterly payments to prevent any penalty issues popping up that they must explain. They also rarely ever check the “refund to tax payer box” on over payments.

    I stopped using financial software years ago, when designing income flows. Paper pencil a calculator and an Excel spreadsheet works best for me and the client. Showing the client how you get the numbers helps them follow the process through. I round everything off where possible to keep things simple.

    I use 3 buckets of money to fund living costs in a flexible way:
    Monthly Spending Account & Tax Deposits ( 3 to 6 month reserve);
    Mickey Mouse(family & fun)Fund and
    Replacement Reserve (car roof emergency dream vacation etc)Fund

    Make it fun keep it simple and keep the numbers to the minimum. Choices, options and variables confuse the process. Remember they have likely never done this before, you have! If you have not done these involve someone who has. Include the clients accountant and attorney in the process, once you have established a solid relationship with the client.

    Keep it simple, make it fun and you will be successful!

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