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Calculating Your Replacement Ratio

When most people think about retirement planning, they think “how much do I need to save?” A commonly forgotten element is “what income will I need during retirement?” One of the key components in calculating your retirement income outlook is estimating your wage replacement ratio: what percentage of your pre-retirement income is needed to fund your retirement years?

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Your replacement ratio will be directly related to how your expenditures change from pre-retirement to post-retirement and how you envision your retirement lifestyle. Taking time to walk through your situation is good for two reasons: 1) it will help you determine what your replacement ratio may be so you can more accurately calculate your retirement guidance, and 2) it will force you to think about how your retirement future might play out. The sooner you start thinking about retirement, the longer you will have to prepare.

Below are a few hypothetical situations to help illustrate how a suitable replacement ratio can vary from person to person.

Example 1: Bob – single, no children, earns $35,000/year

Bob currently rents but plans to buy a home later in life. He has no major expenses and wants to spend his retirement years traveling and playing golf. His employer pays for all of his medical coverage today, but that coverage will end at retirement.

In this example, Bob will likely carry a mortgage through his retirement years, will need to spend more than he currently does for entertainment and will cover his own medical expenses upon retirement. He will likely need to replace 100% or more of his pre-retirement income in order to meet his expected retirement lifestyle.

Example 2: Bill and Cindy – married, children, both have high-paying jobs

Bill and Cindy have high expenses from a mortgage, car payments and funding their children’s college expenses. They plan to have their mortgage paid off at retirement, no college expenses, no other debts, and they don’t expect any major expenditure after they retire. They both envision a modest retirement lifestyle – gardening, fishing and some light travel.

In this situation, they likely need a smaller percentage of their pre-retirement income and can most likely use a replacement ratio of 70% or less.

Example 3: Jennifer and Greg – married, children, one spouse works

Jennifer and Greg have one income and were not able to save for their children’s educations; however, both received full scholarships to their college of choice. They envision a modest lifestyle and little or no debt in retirement, but they anticipate caring for their parents.

Compared with the couple in example two, Jennifer and Greg will likely need to use a higher replacement ratio because they don’t earn as much in their pre-retirement years, and they will have substantial costs related to the care of their parents.

Expense Considerations

These simple examples demonstrate the variety of personal situations that exist, and they highlight only some of the items that you should consider when establishing a required replacement ratio. Before you determine your replacement ratio, there are some major expense considerations you should analyze. (In parentheses, we have written “increase” or “decrease.” These labels describe whether the listed expense will increase at retirement or decrease at retirement.)

Tax expenses (decrease) – Extra deductions are available for people over age 65, and taxable income typically decreases at retirement. Social Security taxes (FICA withholding) end completely at retirement and Social Security benefits are partially or fully tax-free.

Savings expenses (decrease) – Investing for retirement will no longer be needed. Allotting a portion of your income for retirement savings should not be necessary since you already have retired.

Shelter expenses (decrease) – Due to children leaving the home, retirees generally need less space to live. Many people reduce or eliminate mortgage payments in retirement.

Educational expenses (decrease) – Retirees with families typically spent a significant amount of money on education prior to retirement. Additional educational assistance to children will likely decrease or disappear by retirement.

Apparel and services expenses (decrease) – Many of the items and services that you need during your working career are reduced in retirement.

Transportation expenses (decrease) – Another work-related expense that typically drops off in retirement.

Health care expenses (increase) –Medical costs rise as we age, and most of us will lose employer-paid health coverage upon retirement. Many retirees opt for assisted living arrangements later in retirement. These factors, combined with longer life expectancy may require a significant budget for medical expenses.

Utilities expenses (increase) – Spending more time at home means higher costs of heating, cooling, etc.

Entertainment expenses (increase) – Many retirees spend considerable time traveling and pursuing hobbies and leisure interests.

Try to evaluate how each of these expense categories will change when you retire. If you’re uncertain about some of your future expenditures, use a range of expenses to give you a best-case, worst-case and average replacement ratio. We recommend using the higher percentage of the range to provide the most conservative estimate – there’s no harm in over-saving for retirement. If you would like to use a mathematical approach to calculate your replacement ratio, here’s a formula you can use:

Replacement Ratio- How much income will you need in retirement


Retirement Income Quiz

Complete the quiz below and use your total score to see how much of your current income you may need during retirement.

Do you feel you will have more or less debt at retirement than you do now? Think about loans, credit cards, etc.

Less (0)          About the same (1)          More (2)

During retirement, will your mortgage or rent payments be higher or lower than they are now?

Lower (0)          About the same (1)           Higher (2)

During retirement, how much traveling do you plan to do compared to what you do now?

Less (0)          About the same (1)           More (2)

During retirement, how many major purchases do you plan to make yearly compared to what you do now?

Fewer (0)          About the same (1)          More (2)

During retirement, will your recreational/entertainment activities increase or decrease?

Decrease (0)          Stay about the same (1)           Increase (2)

During retirement, how will your out-of-pocket insurance and medical expenses change?

Decrease (0)          Stay about the same (1)          Increase (2)

Quiz Score Approximate Replacement Ratio
0-1 60%
2-4 70%
5-7 80%
8-10 90%
11-12 100%