How much retirement income do you need? It’s a question you can read in plenty of blogs about retirement planning. On the face of it, it sounds like a sensible question. You probably know how much income you’re making before retirement. Maybe you have a fair idea about how much you’re spending before retirement. You may also have aspirations about what you want to spend after retirement. From that you can easily work out the future income you’ll need, right? Wrong!
The fallacy of income replacement
Some time ago, I wrote an article about the so-called 80% rule. This described the rule of thumb whereby you need to plan on replacing 80% of your pre-retirement income. Whether it’s 80% or 75% or any other figure doesn’t matter. The fallacy is to start by determining a required post‑retirement income and then working backwards.
What’s wrong with this? The simple answer is that the income you pick may be the wrong one. If it’s too high it may imply taking more risk; if it’s too low it may lead to spending less than you could have afforded.
Okay, you say, then make sure you pick just the ‘right’ level of retirement income. Well, a fixed percentage of your pre-retirement income doesn’t work, as I previously explained. Is there a more complicated formula that will work? Possibly, but this shows that we’re starting from the wrong place.
Retirement spending not retirement income
Focusing primarily on retirement income can be misleading. The primary focus should be on spending. It’s only after considering likely spending patterns, both before and after retirement, that income replacement becomes meaningful.
There are two types of spending:
- Essential spending, about which you can’t (or maybe won’t) be flexible.
- Discretionary spending, on luxuries that you could flex up or down if necessary.
Once you’ve identified all of your essential spending, in theory it may be possible to identify a sustainable level of discretionary spending. This would also depend upon things including your existing assets and debts, your current income, and your planned retirement date.
An impossible calculation?
I say ‘in theory’ because this calculation is really hard. It’s hard because there are so many variables. It’s even harder because there are so many uncertainties; these include how long you (and your partner if you have one) will live, future inflation, and future investment returns.
Unlike the 80% rule the calculation needs to be tailored to your particular circumstances, and be based on explicit assumptions. This is the kind of calculation financial advisers often wish they could automate. A tool exists that helps with this. It’s designed to be usable without specialist financial expertise, and it’s available to try at no cost. It’s the EvolveMyRetirement® Intelligent Financial Planning Calculator.