In Using Simple Rules to Predict your Retirement Needs, I passively mentioned using 80% rule to calculate retirement needs. You may have heard this rule before; here is a variation of it:
“You need 80% of your pre-retirement income during your retirement.”
Now, that statement is just a rule of thumb and is hardly accurate. Let’s add a bit of reality to the rule:
Income is not a good predictor of financial need. There are people who make much more than what they need. For instance, I doubt Bill Gate need 80% of his gazillion dollars income to retire. Alternatively, there are people who spend more than they earn — in fact, a lot of us are in this category. So, here is the revised rule:
“You need income equivalent of 80% of your pre-retirement expenses during your retirement.”
On average, people spend about 20 years in retirement. A lot of things change in two decades, including the cost of living. Using the rule of 72 and 3.4% average inflation rate, your cost of living will double during the course of your retirement.
80% works, if you want to maintain your standard of living and do nothing else. Sitting at home all day could be pretty boring. Many new retirees tend to live out their dreams — e.g., travel to a different country on an extended vacation, buy a little cabin in the woods, get a nice sport car, etc. In essence, post-retirement expenses could be higher than pre-retirement expenses for a few years.
80% also means that you are keeping pretty much the same standard of living. In reality, there are people who haven’t saved enough, and have to downgrade their lifestyle during retirement. On the other hand, there are people who lived modestly all their lives, saved more than enough money, and planned to reward themselves with a more luxurious retirement.
There is no foreseeable improvement in the rising cost of medical care in the United States. This one is going to hit every retiree hard. Many retirees spend more than their typical 80% living expenses during the few final years — i.e., assisted living facility costs, home health care costs, medical costs, etc.
The theory behind the 80% number is that there are things that will cost more during retirement and things that will cost less. Luckily, there are more things that cost less.