Almost everyone who plans to retire has heard the advice that you should aim to replace 80% of your work-based income once you quit forever. For decades, this rule of thumb was on target. The theory is that simply having a job consumes 20% of your wages. Once you're no longer employed, you'll automatically dial back around one-fifth of your usual spending.
However, even the best-intended and once-helpful advice is subject to eventual failure.
This may well be the case with the 80% rule now. Thanks to uneven cost-of-living increases that disproportionally impact older Americans, replacing only four-fifths of your salary may leave you cash-strapped in retirement. You'll be better off aiming to replace a higher portion of your job's pay.
You can probably guess why this outdated retirement rule no longer works.
Retirement isn't as cheap as it used to be
Numbers from the Bureau of Labor Statistics tell the tale, indicating that in 2022, U.S. residents between the ages of 65 and 74 spent a yearly average of $58,715 simply living life. That's less than their average post-tax annual income of $61,539, but just barely. The difference of $2,824 per year translates into a monthly cushion of only $235. One unexpected expense and retirees will lose fiscal ground.
Moreover, the most likely surprise expenses are also the costliest and the least defensible: spending related to your dwelling. If you rent (and/or intend to rent in retirement), you already know rent rates are through the roof. Although they've been easing since early last year, Rent.com reports that rent rates are still about 20% higher than in March 2020.
Homeowners, meanwhile, are still responsible for the inevitable and increasingly expensive home repairs. SoFi says the average emergency home repair these days costs around $2,300. That's in addition to $3,000 worth of annual maintenance costs.
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The second-biggest typical expense is unavoidable: healthcare.
While retirees 65 or older are eligible for Medicare, the basic program only covers part of their hospitalization expenses. If you want health insurance coverage for more common needs, such as doctors' office visits or prescriptions, you must pay an additional monthly fee for supplemental coverage. No matter how you handle these options, brokerage firm Charles Schwab suggests budgeting between $450 and $850 per month for expenses not covered by basic Medicare. That's much higher than the suggested range just a few years back. And if you need long-term care or live in an assisted-living facility, that added cushion still won't be enough.
This might drive the point home: Data from Gallup indicates around one out of every four people living in the United States who are over 65 forego the purchase of other necessities to pay for healthcare. Similarly, 11% of this crowd has foregone the purchase of medicine within the past 12 months due to its high costs.
Food costs are also much higher than they were just three years ago, and such inflation takes a bigger toll on folks living on a budget than it does more affluent retirees. After all, everyone must eat and pay the same price for groceries (and no one gets a tax break for this spending). The Bureau of Labor Statistics reports that food now costs 24% more than it did before the COVID-19 pandemic, reaching new record levels late last year. It doesn't look like it's coming down anytime soon, either.
Utilities, gas, clothing, and personal services are also considerably more expensive than they were a few years back, with their price growth outpacing income growth.
So, how much of your work income should you be looking to replace once you retire? You'll probably want to aim for 100%.
Start with these actions
That's a tall order, to be sure. Money is already tight for almost everyone. Adding an extra 20% of eventual financial output means coming up with another 20% worth of input (an extra 25% of your current savings rate, mathematically) now. These funds may not be available without major, challenging reductions in your current expenses. It may also call for better returns on what you've saved.
It's possible to do both, though.
As for your household budget, fellow Fool Maurie Backman recently described a strategy that essentially flips the script, making budgeting a bottom-up matter rather than a top-down process by saving first and paying bills second. This will force you to find a way to cut costs, as money that's been accessible suddenly becomes inaccessible. Christy Bieber also offers some helpful budgeting insights.
Regarding stronger returns on your current and future savings, this goal may be more attainable than most people realize.
The old, standard warnings still apply. Chief among these is that being aggressive simply for the sake of being aggressive isn't a sound strategy. Although you generally achieve greater rewards by taking on greater risks, the highest-risk prospects tend to result in complete wipe-outs rather than resounding victories. In other words, be realistic about the risks you're taking. Don't go nuts.
For the vast majority of investors, however, scoring bigger and better returns largely hinges on just paying more attention to your portfolio. Simple things like investing cash as soon as it makes its way into your account rather than letting it trickle into a money market fund is low-hanging fruit. You may also want to own a little less exposure to the bond market so you can hold a little more exposure to stocks. It also wouldn't be crazy to overweight your portfolio with more proven growth sectors like technology or consumer discretionary names -- especially if you have several years until you retire.
More than anything, though, just making a written retirement savings plan -- even a loose plan -- is better than doing nothing. Getting started is often the tallest hurdle.
Any plan is a better way to start than no plan
Will you be able to replace 100% of your employment-based wages when you retire? That's up to you. However, if you know that goal is a stretch, take some solace in the fact that most other future retirees probably won't reach that goal either. And that's OK. You can still fund a nice retirement on less than that amount.
Aim for 100% of your work wages anyway, however. Even if you come up short, you will still be much better off than if you had only aimed for a replacement rate of 80%.
