Retirement spending: Why rules of thumb don’t work

We’ve all heard the rule-of-thumb: To retire comfortably, you need to replace 70 percent to 80 percent of pre-retirement income. Add a couple of percentage points for inflation every year, and you’ll have what you need to meet your expenses in retirement.

But the rule-of-thumb never was meant as a way to think about spending in retirement, says Michael Kitces, partner and director of research for Maryland-based Pinnacle Advisory Group. Instead, it’s always been about income.

“The origin of the rule of thumb was that if you wanted to replace your pre-retirement income, the figure to hit was 70 percent,” he says. “It just referred to the actual income workers take home after adjustments for payroll and income taxes, retirement account contributions, and miscellaneous work expenses, like business clothing and commuting. It wasn’t about a spending ratio when it was first invented, but at some point it morphed into that.”

As a crude estimate, the rule-of-thumb isn’t a bad starting point–so long as you understand your own mileage will vary. “All these averages you see–no one is average,” says David Loeper, CEO of Wealthcare Capital Management. “The average represents everyone lumped together, so it’s exactly the wrong assumption to apply to any individual.”

The rule also is problematic for anyone struggling to achieve retirement in a hard times economy, because it doesn’t start with the right questions: What lifestyle will you want–and be able to afford–in retirement? What will you need to spend on non-discretionary items, like food, shelter, transportation, and utilities? What discretionary spending do you really expect?

For more affluent households, the rule flies in the face of a growing body of financial planning research showing that retirement expenses rarely move in a straight, inflation-adjusted line. A 2005 research paper by financial planner Ty Bernicke challenged the idea that retirees need a constant level of inflation-adjusted income in retirement. Using statistics from the U.S. Bureau of Labor Statistics’ Consumer Expenditure Survey (CES), he showed something different: Retirees over age 75 spend less than retirees age 65-74. And the 65+ crowd spent less than people age 55-64.

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