Realistic Retirement Planning: Avoiding the 80% Rule

If only we didn’t want to spend any money in retirement, planning would be easy. Instead, spending is one of the most critical calculations involved in retirement planning and maybe the most challenging.

Besides spending needs, you also want to factor in annual income and expected years in retirement. For income, add up your sources of guaranteed income (Social Security, pensions, annuity payments, etc.). For your retirement timeline, subtract your retirement age from 95. These numbers aren’t exact, but they offer a decent starting point.

Retirement spending? That’s another matter. Most of us don’t closely track our pre-retirement spending. So instead of reaching realistic, personalized spending figures, it’s tempting to turn to a generic rule of thumb, and assume you’ll spend 80% of your pre-retirement gross income once you retire.

In my experience, I’ve seen retirement spending range from 30%–100% of people’s pre-retirement habits. So, I’d say you’re proceeding at your own peril if you assume 80% is the right percent for you. Remember, retirees don’t get do-overs. Here’s a relatively simple trick for estimating your own current spending.

TAKE your current net paycheck. Add back any fringe benefits that will continue, such as medical premiums. Annualize the amount by multiplying it by however many paychecks you receive annually (such as 26, if you’re paid every other week).
SUBTRACT anything you’ll no longer spend in retirement – IRA contributions, life insurance premiums, office parking, dog walking services, dry cleaning, etc. If your mortgage will be paid off, subtract it too (leaving in ongoing expenses from escrow such as property tax and insurance).
ADD estimated retirement income taxes. For most, they’ll be less in retirement.
ADD any new expenses you hope to incur on additional hobbies, extra travel, dining out, etc.

The results should approximate your ideal retirement spending, at least more accurately than an arbitrary 80%. Compare the results to your guaranteed income, and you’re likely to discover a gap. That’s where retirement planning begins. Can you save up enough before retirement to bridge the gap? Will you need to work longer? Spend less? Combine multiple strategies? We’ll cover some of the possibilities in future articles.

Written by John A. Frisch, CPA/PFS, CFP^®, AIF^®, PPC^®