Many experts say you need 80% of your pre-retirement income to maintain a comfortable lifestyle in your retirement. However, it's possible to live just as comfortably as you do now on a lot less. Here's how you can live on half of your income (or less) with some smart planning in your pre-retirement years.
Where the "80% rule" comes from
Basically, the oft-quoted 80% figure comes from the basic assumption that your postretirement expenses will be close to your pre-retirement expenses, with a few exceptions.
If you've been saving a portion of your paycheck toward your retirement, you obviously won't have that expense anymore. And there are some relatively small expenses that generally get smaller once you retire. For example, you won't have to commute to work anymore, so expenses like gasoline and vehicle maintenance will theoretically drop.
In a nutshell, the 80% rule assumes no major changes in expenses except those that will occur naturally as a result of no longer working. Thus it assumes that you'll still be paying for the same quality of life you had before retirement -- and all of the bills that came with it.
A sample budget
In order to illustrate where the 80% rule of retirement comes from, let's take a look at an example. We'll assume that you and your spouse earn a total of $100,000 per year before you retire and that your effective income tax rate is 20%. This leaves about $6,650 per month after taxes. We'll also say that before and after you retire, you had the following expenses:
|Monthly Expense||Pre-retirement||After Retirement|
|Mortgage (with taxes and insurance)||$2,000||$2,000|
|Utilities (gas, electric, water)||$250||$250|
|Health insurance premiums||$500||$210 (Medicare premiums)|
|Discretionary (remainder of income)||$1,535||$1,535|
|Total||$6,650||$5,595 (84% of pre-retirement)|
Of course, this is a simplified example and doesn't add up to exactly 80%, but you can see why 80% of pre-retirement income is used as a general rule of thumb.
But what if you can eliminate some payments?
I realize that lowering expenses like cable, phone, and groceries could somewhat defeat the purpose of maintaining the same quality of life you had before you retired. And other expenses like utilities are essential costs of living. This leaves your housing expenses and your car payment, as well as any credit card or other debts if you have any.
However, by eliminating one or both of these recurring payments before retirement, you can drastically reduce the amount of income you need. In the above chart, going into retirement without a mortgage or car payment would reduce your income need to just 48% of your pre-retirement salary.
The sacrifice may be smaller than you think
Now, I completely realize that paying extra toward your debts could be a financial burden for the time being. However, don't think of it as "extra." Instead look at it as a choice between three options:
- You can start saving more for your retirement now. If you're confident that your investments will earn returns higher than the interest you're paying on your debt, then there's nothing wrong with choosing this option instead of faster debt repayment.
- You can get more aggressive about paying down your debts before you retire.
- You can do neither and risk having a shortfall after you're retired and unable to do anything about it other than cut back your lifestyle.
And although your quality of life may suffer a bit in the meantime, it may not cost as much as you may think to get rid of your debts before retirement -- especially if you have a long time frame to work with.
For example, let's say you just bought a $300,000 house with 20% down and obtained a 30-year mortgage at 4% interest, which would make your monthly payments $1,146. And let's say you'd like to retire in 20 years. How much do you think you'd have to add to your monthly payments to pay off your mortgage in 20 years instead of 30? $500 maybe? $600?
Actually, by adding $310 to your monthly payment, you would own your home free and clear in exactly 20 years. On top of that, you'd save yourself more than $60,000 in interest in the process.
This can take a tremendous burden off your shoulders
If you can live on less income in retirement, you'll need less saved up before you retire. Let's assume that in our example, you expect to receive $30,000 in Social Security income between you and your spouse. This means $37,140 of your annual post-retirement income requirement will need to come from your retirement savings if you have a mortgage and car payment, and just $7,140 if you don't.
So, based on the "4% withdrawal rule" of retirement -- which isn't perfect but it is a good rule of thumb -- you would need to have $928,500 saved if you had a mortgage and car payment, and just $178,500 in savings if you can eliminate those expenses. That's a big difference in the amount of money you'd need to save.
Make debt management a priority
In a nutshell, the best way to lower the amount of retirement savings you need is to eliminate your post-retirement expenses. So, if this sounds appealing to you, make it a priority to have your home and car paid off before you reach retirement age. And here are a few suggestions to get you started.
- Use a biweekly payment plan to pay off your mortgage. Doing so can mean you'll pay off your mortgage several years sooner and save thousands in interest.
- Take your tax refund every year and apply it to your mortgage.
- Trade down to a less expensive car that you can afford to pay for in full.
Of course, these are just a few suggestions. There are thousands of possible ways to cut back on expenses and pay down your debts faster.
Now, it's important to note that the end result of paying your debts faster and increasing your retirement savings will (theoretically) have the same effect on your finances, both now and once you retire. If you decide to pay down your debts faster, you'll still have less discretionary income now, just as you would if you decided to increase your savings rate. And both ways are completely valid strategies to be able to keep up your current lifestyle after you retire.
Still, it's completely understandable that many people would prefer their debts to be as low as possible, in order to keep expenses low, so if you'd prefer to retire with a "simpler" financial situation, getting out of debt is a good goal.