Income Replacement Percentages
Income replacement percentages during retirement are used by planners as rough guides in determining the amount of income needed in retirement, using preretirement income as a base value (100%). Thus, it is common to hear financial advisors myself included to state that retirees need 85% of preretirment income to support a similar lifestyle in retirement.
One would expect that these percentages can vary greatly between individuals depending on their plans for retirement years. Two clients with very similar incomes and assets may have vastly different plans for how they will live in retirement. For example my retirement goal is to spend most of my time in Medellin, Colombia. My expenses when I leave NYC will drop dramatically. However, my business partner plans to retire to a swank golf community in Naples, Florida. Same income and assets but very different retirement plans. My replacement income ratio can drop to 50% his will likely stay the same or even increase.
Income replacement percentages is where we begin
Don’t put too much stock in aggregate income replacement percentages. Keep in mind that these ratios, like the rules of thumb for life insurance needs, are a convenient way to assess the reasonableness of a client’s retirement goals but should never be used as the only basis for planning. Income replacement percentages are most useful for young clients as a guide to their long-range planning and investing; however, for individuals and couples withing 250 or fewer years of retirement, a thorough analysis of current and anticipated retirement expenses is necessary to establish reasonable retirement income needs.
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