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How Much of Your Income Will You Need to Replace in Retirement?

By Christy Bieber – Feb 18, 2020 at 7:03AM

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Don't just follow the standard rule of thumb.

Social Security benefits are designed to replace around 40% of your pre-retirement income. Unless you have a pension, any additional money you need has to come from savings.

That means it's important to understand how much of your pre-retirement income you'll actually need to live on. Figuring this out can help you decide if you're ready to retire, since otherwise it might be difficult to estimate just how much money your investments need to produce for you. 

Older man grabbing away piggy bank from grasping hands.

Image source: Getty Images.

Here's how to figure out the amount of pre-retirement income you'll need to live on

One common rule of thumb is that you need 70% to 80% of pre-retirement income to maintain your standard of living. Unfortunately, this is a wide range. And it doesn't work for everyone. In fact, some people actually end up spending more in retirement than before leaving the workforce. 

If you want to be a little more precise, take a look at your income and subtract some of the costs you won't incur as a retiree -- such as 401(k) contributions you're currently making and some transportation costs if you're currently commuting to work. If you plan to downsize and sell your home, you can also subtract some of your housing costs as well. 

Once you've got an idea of spending you'll drop, it's time to do some additions to account for new costs you'll incur as a senior. If you think you'll be traveling more often, you may decide you want to add in some additional funds for trips. You should also plan for increased medical care costs, as it's common for seniors to incur several thousand dollars annually in out-of-pocket expenditures. 

Don't forget to take your changing tax situation into account as well. While you have to pay taxes on withdrawals from traditional 401(k) and IRA accounts, you won't be taxed on withdrawals from Roth accounts. And Social Security benefits are only subject to federal taxes if your countable income exceeds a certain amount. If you'll get most of your money from Roth accounts, or if your income will drop and your tax bracket will fall, you won't need as much money to pay the IRS. 

By considering all of these changes to your specific situation, you can get a better idea of how your spending habits will change going into retirement. That way, you can estimate the percentage of your pre-retirement income you'll personally need, rather than just following the standard rule of thumb. 

Always consider the specifics of your situation

If you go by the standard rule and estimate you'll need 70% to 80% of pre-retirement income, you may think you have enough to retire, but could find yourself in financial trouble if you overspend. On the other hand, if a ton of your money is currently going to costs that will go away as a senior, you may think you need to work longer when really, you're ready to turn in your notice. 

By looking at the specifics of your financial situation, you can make the right choice about when your retirement account balance is big enough. And you can reduce the chances of ending up with too much or too little money to live the lifestyle you've dreamed of in your later years.

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