When planning for retirement, you might be inclined to use an oft-quoted rule of thumb that has you striving to replace 80% of your income in retirement.
Don't — there is no absolute standard, according to Michael Hurd, a principal senior researcher and director of the Center for the Study of Aging at the RAND Corp., and Susann Rohwedder, a senior economist and associate director of the Center for the Study of Aging at the RAND Corp., in Santa Monica, Calif.
Instead, Hurd and Rohwedder say you really need to customize your income needs in retirement based on highly personal factors such as your marital status, education, gender, age, whether you have children, and your economic resources, such as your post-retirement income, your housing wealth, and your non-housing wealth.
"Both economic theory and common sense say that someone is adequately prepared (for retirement) if she is able to maintain her level of economic well-being, which is not the same as maintaining her level of income or some fixed proportion of income because of the accumulation and de-cumulation of wealth," wrote Hurd and Rohwedder in a recent paper. "Consumption is a better measure of well-being or utility than the level of income at some particular point in time."
According to their research, household spending before retirement will typically be substantially less than income before retirement because of taxes, Social Security contributions, work-related expenses, and most importantly because of savings for retirement. By contrast, consumption after retirement will typically be greater than income because of the ability to spend out of savings. Furthermore, Hurd and Rohwedder noted many retired households pay little or no taxes and make no Social Security contributions. The implication is that income could change by a great deal at retirement, yet consumption could be maintained, they wrote in their paper, Economic Preparation for Retirement.
And when viewed in terms of consumption rather than income replacement, Hurd and Rohwedder found in their research that about 70% of individuals age 66 to 69 in the mid-2000s were adequately financially prepared for retirement.
But some individuals, given their by education, sex, and marital status, were not financially prepared, most notably single females who lack a high school education. Just 29% of that group is adequately prepared, according to Hurd and Rohwedder.
Given the findings in their research, Rohwedder offered this advice to those saving for or already living retirement:
• Differences by marital status and education. "There are large differences in the chances to survive to advanced old age by marital status and education," she says. For instance, the wealthy tend to survive longer than the poor. And married couples tend to live longer than single people. Consider: a 62-year old married male with high education has a 50% chance to survive to age 90, but a 62-year old single male with low education has a 50% chance to survive to age 75.
"For someone facing low chances of survival to advanced old age resources won't need to last as long. Conversely, some will have a pretty high chance to survive to advanced old age and need to take that into account," she says.
• Predicting one's desired consumption level during retirement is key. "Some people envision a retirement full of travel or other activities that require money," says Rohwedder. "Others envision a retirement of taking care of house and garden and spending time with friends living close by."
One retirement might require a large nest egg, while another might require a modest nest egg.
• Spending during retirement is not flat. According to Rohwedder, spending tends to decline with age for the vast majority of people. So, as you move from what some describe as the go-go years of retirement to the slow-go years to the no-go years, you'll likely spend less money on travel or other leisure activities that require money. Plus, you'll likely spend less money on transportation, clothes, and the like. "Many people do not realize this as they are trying to look ahead," says Rohwedder.
• Get a full assessment of retirement resources. When planning for retirement, it's critical that you examine all your sources of income, be it Social Security, earnings pensions, distributions from taxable and tax-deferred accounts, as well any and all assets that can could be used to finance spending. And one asset that's critical to factor in is your house. To be sure, most retirees use the equity in their house as a last-resort asset. But you still need to factor this into your retirement balance sheet and cash flow statements.
• Don't forget taxes. "Taking into account taxes is important in the full assessment of retirement resources," says Rohwedder. "While some people pay very little in taxes during retirement, those with considerable balances in pre-tax retirement accounts face a sizable tax bill."
• Be mindful of long-term care expenses. According to Rohwedder, long-term care expenses can be sizable, which is of particular concern for couples if one spouse needs nursing home care while the other one is still alive and living in the community and not in need of nursing home care.
In some cases, long-term care insurance might be an appropriate way to mitigate the risk of long-term care needs. But a word to the wise is in order: "Long-term care insurance policies often are designed in ways that leave considerable risk uninsured and therefore may not be appropriate for many," says Rohwedder.
Robert Powell is editor of Retirement Weekly, a service of MarketWatch.com. E-mail him atrpowell@allthingsretirement.com.
