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Retirement Savings Goals Should Be Based on Expenses Not Income

Written by Nickel - 11 Comments

Retirement Savings Goals Should Be Based on Expenses Not Income

Over the past few months, I’ve seen several instances in which people are advised to save X times their income for retirement. I first noted this back in July when an Aon Hewitt survey suggested that you should have at least 11x your annual income set aside for retirement.

In his book “Your Money Ratios,” Charles Farrell argues that you should have 12x your annual salary in the bank before retiring. And the New York Times recently suggested that you should have 20x your annual salary stashed away.

My view — and one that was recently echoed by my pal Mike Piper — is that this is a highly flawed line of thinking. Instead of focusing on income, you really need to be focusing on expenses.

While I realize that many people are living paycheck-to-paycheck, in which case income and expenses are essentially the same, that’s not the case for everyone. And it also ignores the possibility that you’ll scale back your lifestyle in retirement*.

I’ve said it before and I’ll say it again… To estimate how much you’ll need, start by estimating your post-retirement expenses. Average it out across a year. From there, estimate what sort of investment returns you’ll be able to generate — yes, you’ll need a crystal ball for this.

From there, divide that rate (as a decimal) into one to find your multiplier. So, for example, if you think you can generate 4% real returns (i.e., 4% returns after accounts for inflation, so more like 7% nominal returns) then you’ll need 25x your annual expenses (1 / 0.04 = 25). If you think you’ll only be able to generate 3% real returns, then you’ll need 33x your expenses. And so on.

Don’t forget about things like pension payments and Social Security (the latter is hard to predict, I know). These sorts of income streams will offset a portion of your expenses, and should be subtracted out before calculating your multiplier.

So… Assuming you’ve done the math, what’s your reaction? Does that number look scary large? Or are you well on your way?

*Note: Don’t be too cavalier with your assumptions here. Once retired, you’ll have more time on your hands and you’ll also face increasing medical costs as you age. But you’ll hopefully be living mortgage free at that point, and so forth, so it’s not out of the realm of possibility that your expenses will dip.

Published on September 12th, 2012
Modified on September 18th, 2012 - 11 Comments
Filed under: Retirement, Saving & Investing

About the author: is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

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11 Responses to “Retirement Savings Goals Should Be Based on Expenses Not Income”

  1. 1
    Christian L. @ Smart Military Money Says:

    Oh boy, how unconventional of you! I kid.

    I’m still a tad too far from retirement to really apply this method, but I think in a year I’ll do it. And no, I haven’t said that before.

    -Christian L. @ Smart Military Money

  2. 2
    Tahoe Joe Says:

    For those few of us who actually have lived below our means, this is excellent advice. I have always questioned the use of % of income as the standard. I planned my retirement based on my expenses (assuming they would roughly remain the same) and so far it has worked out well for me.

  3. 3
    sf Says:

    This is one of those “duh!” concepts: I’ve done my retirement modelling for years by attempting to project expenses forward. Current income has nothing to do with those projections but current expenses sure do affect my thinking about what future expenses might be.

    By the way, the corollary to that is if you cut expenses now two things happen: You get used to “living below your means” so your future expenses are lower. And you are saving more to cover those future expenses.

  4. 4
    MoneySmartGuides Says:

    I always dislike when experts claim that your expenses in retirement will go down. You have no idea if they will or not. In many cases, I would argue they go up. You aren’t going to be sitting at home all day long every day. You are going to travel or pick up new hobbies. The money you ’save’ by not traveling to work and for other work related items can easily be spent in other places.

  5. 5
    Lance @ Money Life and More Says:

    I think the reason people focus on income is because it is something that they can readily figure out. A lot of people have no idea how much their expenses will be when they retire and don’t want to take the time or effort to figure it out.

  6. 6
    BG Says:

    Save every penny you possibly can, then double that: that is how much you need.

    Without real income generating investments, not sure I would consider retiring.

  7. 7
    Erik Says:

    Its not also out of the realm of possibility that your expenses will go up in retirement. (The mortgage payment may disappear, though for many that are retiring, this may have been gone for a while.) It is a lot easier to go golfing, eat out, (or take part in any other leisure activity) when you are are not forced to sit at a job 8-10 hours a day.

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  10. 10
    zimmy@moneyandpotatoes.com Says:

    I think that it is easier for me to just accept that fact that I will not be able to fully retire. My wife and I will always need to have at least part-time jobs to make sure the bills are always paid. I am not one who would just sit on his butt during retirement anyways and welcome the challenge.

  11. 11
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