A common rule of thumb for retirement planning is that you’ll need 80% of your pre-retirement income to cover your expenses. Though this guideline has been around for decades, it’s based on assumptions that may or may not be entirely true for all retirees.
The Logic Of The 80% Rule
The 80% rule is based the fact that, when you retire, you won’t be dealing with certain deductions from your earnings. For example, when you retire you won’t be contributing to your FERS annuity (pension) and Thrift Savings Plan (TSP) or paying Social Security taxes.
One downside is that the 80% rule assumes your expenses in retirement will be lower because you’ve paid off all of your debt before you submit your retirement application. However, if you’ll still be making payments on credit cards, loans and a mortgage in retirement, the 80% rule may not apply to you.
Replace 80% Of Income At What Point In Your Career?
Your income at mid-career will be lower than your income the year before you retire. Add to this your expenses at these two points in your working life will also be vastly different. At age 40, you’re likely still supporting kids living at home and either saving for, or in the process of, paying for college tuition. Payments on your 30-year mortgage are higher at 40 than 20 years later at age 60 or older. Which point in your career do you use when applying the 80% rule? It’s never been entirely clear but most assume it’s the last year or two before retirement.
“In their later years, expenses may increase again due to chronic, age-related health issues and the need for long-term care that’s not covered by insurance.”
The 80% Rule & Retirement Spending
Another downside is that the 80% rule ignores changes in retirement spending over time. Retirees tend to spend more in the first couple of years on things like travel, dining out and entertainment. As a result, they may need 100% of their pre-retirement income to cover early retirement expenses. Their spending slows down in the middle years of retirement until expenses begin to increase due to chronic, age-related health issues and the out-of-pocket cost of healthcare and long-term care that’s not covered by insurance.
There’s No One-Size-Fits-All Retirement Plan
With your FERS pension, Social Security and TSP distributions providing three sources of retirement income, you’re in a good position. Then again, everyone’s financial situation is different. The best way to determine if the 80% rule applies to you is to calculate your projected income and expenses over a 30-year retirement and then adjust it for inflation.
If you need help crunching the numbers, connect with an FRC® trained advisor.
