This retirement-plan building block is cracked
Marketwatch, October 30th, 2009
The rule of thumb is that you'll need to replace 70%
of your pre-retirement income on average once you retire, but evidence
continues to mount that this assumption by many professionals and
retirement savers is way off base.
Now, a new study by two professors casts further doubt on the idea that
the widely used replacement-rate figure is a sound basis for building a
retirement plan.
"The rule of thumb that replacement rates should be above 70% to
maintain living standards in retirement is conceptually flawed," wrote
John Karl Scholz and Ananth Seshadri, two University of
Wisconsin-Madison professors, in their paper "What Replace Rates Should
Households Use?"
In fact, no more than 15% of the population Scholz and Seshadri studied
need to replace 65% to 90% of their pre-retirement income. And almost
50% of the population needed to replace less than 65% of their
pre-retirement income.
In short, the authors said: More refined guidance is needed to serve households well.
Costs usually decrease in retirement
Target replacement rates are less than 100% for three main reasons,
according to the study published by the Michigan Retirement Research
Center.
"First, upon retirement, households typically face lower taxes than
they face during their working years, if for no other reason than
Social Security is more lightly taxed than wages and salaries. Second,
households typically save less in retirement than they do during their
working years, so saving is a smaller claim on available income. Third,
work-related expenses generally fall in retirement."
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