Generally in retirement, people want to go on living mostly the same way they did during their working years (except without that tedious going-to-work part). They want to buy the same kinds of groceries, pursue the same hobbies, and shop for clothes at the same stores. There might be outliers: a person with a modest income who dreams about retiring to an ocean-view house with a sailboat, or a couple with a big house and an expensive lifestyle who plan to downsize and live simply in a two-bedroom house, working in the garden. But these outliers aren’t the people economists are talking about when we discuss the big issues surrounding retirement. We’re talking about the average person who wants to lead a life that fits into approximately the same budget.
But how do you put “pre-retirement standard of living” in dollar terms? Here’s what you need to know.
If you’re like most people, in retirement you’ll need 70 to 80 percent of your pre-tax, pre-retirement income. If you earn £100,000 per year, you’ll need £70,000 per year, at minimum, to maintain your standard of living. Personally, I’m aiming for 100 percent. But many people can live on a bit less because they won’t have work expenses in retirement: commuting costs such as gasoline and bridge tolls, upkeep on a work wardrobe, the expenses of child rearing, and, of course, saving for retirement. However, some costs will increase as you age—medical expenses, for example. Ideally, though, you’ll see a net drop in expenses.
An important note here: The 70 percent target assumes you’ll have paid off your mortgage by the time you retire. Start making plans now to make that happen, because the numbers on this point are trending downward. In 2014, only 65 percent of older people were mortgage-free, whereas in the 1980s, more than 80 percent of seniors owned their home outright.
The biggest factor in whether you can live comfortably on 70 percent of your previous income is where you stood on the income ladder most of your life. Wealthy people who are willing to cut non-necessary expenses can get by fairly easily on 70 percent. The working poor, however, can’t. They’ll likely need more than 100 percent, because they have no indulgences to trim from their budget, and medical expenses increase substantially after retirement, even with insurance.
It’s likely that you fall somewhere between those two extremes. That’s why economists suggest that for many middle-class individuals, closer to 80 percent of pre-retirement income is approximately what’s needed. That is an argument for downsizing your lifestyle now. Why? Because you’re almost certainly not going to have 100 percent of your income in retirement. In fact, if your employer doesn’t offer a pension, and you’re one of the one-third of middle-class Americans who has no money in a retirement account, you’re likely on track to have about 40 to 50 percent of the annual income you had in your working life. In 2011, married Americans aged 55 to 64 in the bottom half of income distribution had assets of only £130,000, including their house. Those couples in the next 40 percent of income distribution, with incomes between £52,000 and £140,000 a year, had an average of £350,000 in total wealth—home equity, retirement accounts, and so on.
And married couples in the top 10 percent? I’m still worried about them. Yes, they have incomes above £140,000 per year and an average total of about £450,000 in their houses, retirement accounts, and so on. But assuming half the wealth is in their house, leaving them with £220,000 to draw down over the rest of their lives, that’ll give them about £10,000 per year—which, even with Social Security, is a long way away from £140,000.
Honestly, I’m not trying to scare you into hopelessness here. It’s the opposite: I hope to motivate you to fiercely pursue a solid solution to your old-age income challenge. First, we’ll start with a realistic picture of the future, so you can bring your savings and your current lifestyle into line with it. Once you know you’re on track to cover the bare minimum of what you’ll need later, you can always save more.