Should Retirement Investors Target 100% Income Replacement Instead Of The Traditional 80%?

The Wealth Advisor Contributor

February 8, 2023

(TheStreet) - Inflation can be a significant concern for retirees since it reduces their savings and fixed-income purchasing power. As a result, they may need help to maintain their standard of living and pay for necessities.

To maintain their purchasing power while also keeping up with the rising cost of living, retirees may want to consider setting more significant income goals in an environment of high inflation. In this article, we'll look at how inflation affects retirees and talk about ways to boost income and keep your finances stable in retirement.

We will also look at the advantages and disadvantages of other sources of income, including investments, part-time employment, and government assistance.

What is the 80 Percent Rule for Retirement?

According to the "80 percent rule," retirees should attempt to replace 80% of their pre-retirement income to keep their standard of living in retirement. In retirement, retirees are supposed to spend less money because they won't need to save for their future, won't have to pay for transit, and won't have any other expenses related to their jobs. As a result, they will only require as much money as they did while working.

Advantages of the 80 Percent Rule in Retirement

Preparing their retirement income offers retirees a fundamental framework to adhere to. The 80 percent rule can be used as a starting point for retirement planning for many seniors who are still determining how much money they will require.
It accounts for the fact that retirees' retirement expenses will be lower. Retirees will have a cheaper cost of living because they won't have to commute, save for retirement, or pay for work-related expenses. As a result, they'll require less money to maintain their current quality of life.
Setting realistic income objectives helps seniors understand their financial needs in retirement. For retirees, the 80 percent rule might serve as a baseline against which they can compare their predicted income and make any required modifications.

Disadvantages of the 80 Percent Rule in Retirement

There are only so many effective approaches. The 80 percent rule may not apply to every retiree because every situation is different. It ignores factors like the cost of living in the retiree's neighborhood, their lifestyle preferences, and any outstanding loans or mortgages that may impact how much money is required to maintain their standard of living.
The possibility of unforeseen costs, such as medical expenses, is not considered. The 80 percent criterion does not consider that healthcare costs can be substantial in retirement. The retiree's financial strategy may be affected by these high unforeseen costs.
It ignores the possibility that some retirees may have a higher cost of living because of travel or hobbies. The 80 percent criterion does not account for retirees who love expensive hobbies or frequent travel. These retirees may require additional income to maintain their standard of living.

Why is the 80 Percent Rule Inadequate in Recent Times?

The 80 percent rule of thumb suggests that retirees strive to replace 80 percent of their pre-retirement income to maintain their standard of living in retirement. However, several current circumstances may mean this rule needs to be revised. The first is that as people live longer and they need to save more money to pay for a longer retirement. Many retirees live into their 80s and 90s, so they need to have enough funds to survive for at least 20 to 30 years.

Additionally, healthcare costs have increased dramatically in recent years, which can be costly for retirees. Costs associated with healthcare are frequently unpredictable and high, particularly for retirees who may need long-term care or have several chronic health concerns. Because of this, it may be hard for retirees to keep up their standard of living, and their money may run out.

Since savings account interest rates have been low in recent years, retirees may not be capable of generating the income they require to sustain their standard of living. Low-interest rates make it harder for retirees to keep the buying power of their assets. This is because inflation can eat away at their savings over time.

When looked at as a whole, the 80 percent rule may be needed for many retirees to keep up their quality of life. They may need to save more and plan their retirement more carefully.

Should Investors Target 100% Instead 80%?

The percentage of pre-retirement income that an investor should seek to replace in retirement is a question of personal preference. It is determined by a person's unique circumstances and aspirations. Financial advisors frequently advise clients to adhere to the 80% replacement rule, but not everyone can. Some investors may aim for a more significant proportion, like 100%, to ensure they have enough money to support their pre-retirement way of life without worrying about running out of money.

Retirement freedom and possibilities can be increased for retirees by setting a goal of completely replacing pre-retirement income. They can maintain their current way of life and avoid having to alter their spending patterns significantly. But it's essential to remember that aiming for 100% replacement would necessitate a bigger retirement savings portfolio, which might only be possible for some.

It could be challenging to build up enough funds to replace 100% of pre-retirement income, depending on a person's lifestyle and spending patterns. Additionally, retirees might spend less in retirement than when working on commuter fees and work-related expenses, which can reduce the need for a replacement rate of 100%.

It's also crucial to remember that retirees must budget for greater inflation rates than they would have experienced while working to preserve their funds' buying power. This can be a problem, especially if interest rates are low, since low-interest rates usually mean less money from investments.

Retirees may also receive income from Social Security, pensions, or rental income in addition to their portfolio, which is another factor to consider. These sources of income can lessen the need for a 100% replacement rate by complementing retirement income. When choosing their goal replacement rate, investors should consider all potential sources of income.

It's essential to remember that retirement might extend for several years and that an investment portfolio can experience many market cycles and returns. Because of this, it's essential to have a diversified portfolio and a plan for handling withdrawals in different market situations.

Finally, the amount of pre-retirement income that an investor should try to replace in retirement is a choice that depends on a person's unique situation and aspirations. Some financial experts advise aiming for an 80% replacement, while others advise aiming for a more significant percentage, like 100%.

Investors should consider their objectives and retirement lifestyle, as well as their anticipated sources of income and outgoing costs. They should also routinely assess their retirement plan and make any necessary modifications, such as raising their savings rate, changing their investment approach, or altering their spending schedules. To get a customized retirement plan that considers your unique situation and aspirations, it is always a good idea to speak with a financial expert.

Risks of Targeting a Higher Level of Income for Retirees

In an environment of high inflation, retirees might need to set their sights higher to maintain their living standards and the purchasing value of their funds. But there are inherent risks in aiming for a higher income level.

One risk is that retirees could only outlive their investments if they remove less money from their portfolios. Higher-income withdrawal rates raise the danger of running out of cash in retirement by shrinking the size of the investment portfolio over time. This risk can be reduced by carefully controlling withdrawal rates and keeping an eye on the portfolio's performance.

To keep a more significant income level, retirees risk being overly conservative in their investment approach. In rising markets, a more conservative portfolio could not perform as well, which could lead to lower returns and a lessened capacity to keep up with inflation.

A third risk is that retirees need help thinking about the tax repercussions of taking out a larger income. Income taxes may apply to withdrawals from some accounts, such as traditional 401(k)s and IRAs, which can lower the amount of money available to cover expenses.

Retirees must strike a balance between aiming for an income high enough to cover their needs and maintaining the purchasing power of their assets while also controlling risks and extending the longevity of their investments. To develop a personalized strategy that considers the retiree's unique circumstances and aspirations, as well as the current and anticipated future inflation rates, it is always a good idea to speak with a financial advisor. This can help you manage your retirement income, diversify your portfolio, and make sure you have a plan that will last.

Bottom Line

In conclusion, rising inflation can deplete retirees' funds, making it challenging to sustain their standard of living in retirement. Retirement investors should pursue a higher income level from their investments to stay up with inflation as a solution to this issue. Seeking a higher income level entails several risks, such as running out of money in savings, choosing an overly conservative investing plan, and failing to consider the tax consequences of withdrawals. For retirees, it's crucial to find a balance between aiming for a high enough level of income to cover their demands and retaining their assets' purchasing power while minimizing risks and ensuring the durability of their savings.

By Guest Contributor
February 3, 2023