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Replacement Rates

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One of the biggest questions on the mind of employees when planning for retirement is: How much should I have saved before I retire?

Answering this question is difficult, because the question is not complete. The real question is: How much should I have saved in my retirement account to support the income and lifestyle that I want?

To answer this question, you first need to decide what level of income you would like to support the lifestyle you would like to live. One of the best ways of doing this is determining your replacement rate. Your replacement rate is simply the percentage of your pre-retirement income that you want to replace with retirement savings.

Typically, replacement rates are between 70% and 80% of pre-retirement income. This is because expenses tend to go down in retirement, and retirees are no longer saving 10-15% of their income for retirement. The burden on your retirement portfolio can be further reduced by social security as well. For example, if you are earning $50,000 annually before retirement, and expect to need $40,000 annually in retirement, your replacement rate is 80%.

Your replacement ratio might be different. In retirement you may want to take more vacations, spend on grandchildren’s education, or just be more active in general. This could cause your expenses to go up. Sitting down and budgeting the things you need in retirement and the things you want in retirement can go a long way to understanding your projected income needs and your replacement rate.

Once you have determined your replacement rate, determining whether or not you can support it becomes much easier.