New research complicates the ‘80% rule’ for retirement savings

The key question for retirement savers is to calculate how much – through a combination of savings, pensions, and Social Security – of your pre-retirement income you’ll be able to replace after you leave the workforce. 

The “80% rule” is an oft-mentioned general guideline for savers. The idea is if you make, say, $100,000 a year, then you need to be able to generate $80,000 per year in retirement.

New research looking at what people actually spend complicates this rule.

These findings suggest wealthy retirees don’t really spend down their money, said Michael Finke, a professor at the American College of Financial Services, which focuses on professional training for financial practitioners.

“For a lot of upper-middle-class or higher-earning Americans, they may not need to replace as much of their pre-retirement income as they think,” Finke, who co-authored one of the papers on this topic, told Yahoo Finance.

He estimates that if someone is “making over $100,000 a year, then they probably only need to replace 50% or 60% of their income to maintain the same lifestyle that they had.” (Finke appeared as part of Yahoo Finance’s ongoing partnership with the Funding our Future campaign, a group of organizations advocating for increased retirement security for Americans.)

His research with three colleagues looked specifically at higher-income retirees and found what they called a consumption gap. Put simply, a lot of wealthier retirees “end up getting wealthier in retirement,” Finke says.

The researchers note that retirees with median wealth have a consumption gap of just 8 percent on average, while “retirees with higher levels of wealth have a consumption gap as high as 53 percent” – meaning the wealthier retirees spent about half of what they generate in income from investments and savings.

They also found that the consumption gap widens the deeper you get into retirement. One of Finke’s co-authors has studied the phenomenon, which they note “is inconsistent with general economic theories on consumption.”

Piggy bank on money concept for business finance, investment, saving or retirement fund

Finke posits that spending falls over time “as a result of physical and cognitive changes in old age.”

A different story for those on the lower end of the income spectrum

Finke says the 80% rule only really works for those earning around $50,000 annually.

Lower- and middle-income households are more likely to run out of money during retirement, especially if they haven’t set aside money for medical expenses. Wealthier retirees tend to have more assets, including real estate investments and dividend-yielding stocks, which have historically provided enough money to live on.

It gets more challenging for those with less earning power.

For example, if you make between $20,000 and $30,000, the research suggests you’ll likely need to be able to generate more than 100% of your pre-retirement income if you hope to stop working – even with the help provided by Social Security.

Lower-income Americans will likely face a steep climb to reach those savings levels given statistics from before the coronavirus pandemic that found one in three Americans had less than $5,000 saved for retirement.

And the ongoing crisis makes the picture even more complicated. “This is a critical time,” says Finke, because savers are “going to have to make a decision about whether to dip into those defined contribution savings.” 

If people at the lower end of the income spectrum, who have been hit hardest by job losses, have to tap into those funds, it could leave them even further behind.

Ben Werschkul is a producer for Yahoo Finance in Washington, DC.

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