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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.

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