If you’ve read virtually any financial literature before, you’ve likely come across the notion of the “70% Rule” for retirement income. The rule simply states that a comfortable retirement income should equal approximately 70% of the after-tax income in your working years. For example, a couple who takes home a combined $8,000/month, while working, should strive for an after-tax retirement income in the neighbourhood of $5,600/mth.
But… is this a good rule? Does the 70% target work when put into practice?
Why 70% Works, In Theory
When you’re in your working years, you likely have a great deal of cash outflows that won’t stay at the same level once you retire. Expenses like:
- Saving for retirement,
- Your mortgage,
- Payroll deductions (CPP, EI, Union Dues, etc…),
- Cost of commuting and/or parking,
- Work wardrobe,
- Feeding, clothing, or supporting children
Without these expenses, it can be quite common to see a substantial drop in your monthly income needs. If you take the time to work through your budget or track your expenses, you’ll have a great idea as to how much these add up! If you’ve never done an in-depth analysis on your cash flow, using a ballpark estimate that they add up to 30% sounds pretty reasonable.
Having a rule of thumb also works really well from a conceptualization standpoint. As people, we tend to appreciate some context for where we stand, relative to the average. If you believe the “average” Manitoban gets by on 70% of their income, surely you’ll feel good about doing the same! The 70% rule can give you the mental confidence in making the transition to retirement.
Why 70% Doesn’t Work
The short answer is: not all people are the same! Every circumstance is different and we can’t neatly average it out to a single ratio.
Some people will need to replace MORE than 70% of their income. Perhaps they’re still carrying a mortgage in retirement or financially supporting parents, kids or even grandkids. Maybe their retirement goals are costly; foreign vacations, country club memberships, and any other number of hobbies can quickly add up. There are countless reasons why a retiree may have ongoing bills in excess of the 70% mark.
Other folks will need far LESS income replacement in retirement. I’ve met with countless pre-retirees who have built very enjoyable, but frugal lifestyles. Their working career income has far exceeded their basic needs, interests, and hobbies. Trying to keep their incomes at 70% of their working levels would only result in drawing money from one pot to turn around and save it in another.
There are equally as many reasons why the denominator (a.k.a. their working career income) doesn’t support this rule. For a Manitoban family who is just making ends meet while in the workforce, slashing 30% out of their budget simply isn’t doable. They may need 80%, 90% or even 100% income replacement just to maintain their standard of living. For high income earners, the opposite is equally true. They could be in the enviable position of maintaining their lifestyle with only a tiny fraction of their annual career earnings.
What Should I Do?
It’s not the fun answer, but the right answer is to budget. Start by tracking your spending as it exists today. Take careful notes over the course of a month where you spend and how much. Once you’re done, you can take a pencil to your spending habits and cross out everything that will go away when you’ve stopped working. Also add in any new costs that will come about for your retirement lifestyle. Now you have YOUR number and it’s almost certainly NOT 70% of what your take-home pay is today.
You can build a retirement plan around 70% of your income very easily. But if it’s wrong, you’ll wind up either outliving your money or unnecessarily delaying retirement altogether. The 70% rule can make for a great baseline, or a realistic goal if you’ve never thought through expenses, but it will never replace the accuracy of a real budget.
Recent Comments