Retirement Replacement Ratio & Adjusted Expense Method

Retirement Replacement Ratio & Adjusted Expense Method
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A 2102 study by Aon Consulting found that the average person needs to replace 85 percent of her paycheck at retirement to maintain her standard of living. The study also found that the typical worker ends up with a 20 percent shortfall of retirement resources. Retirement replacement ratio and adjusted expenses are methods for projecting individual retirement income needs to guide your retirement planning.

Calculating Replacement Ratio

The formula for retirement replacement ratio is gross post-retirement income divided by gross pre-retirement income. If you earn $80,000 the year before you retire and have retirement income of $60,000, the replacement ratio equals 75 percent. Estimate retirement replacement income by adding together income from Social Security, investments, pensions and other sources. Retirement replacement ratio only tells you how much retirement income to expect, not how much you actually need.

Adjusted Expense Method

The adjusted expenses model is better suited to estimating retirement income required to maintain your pre-retirement standard of living. Add likely expense increases to your pre-retirement income, such as replacing employer-provided health insurance. Subtract outlays like work-related expenditures and the money you are now saving for retirement. Factor in age-related tax breaks. The result is the estimated retirement income you need. Convert this expense to a ratio of pre-retirement income. Suppose your analysis shows you need retirement income of $68,000 to replace pre-retirement income of $80,000. That’s 85 percent. Compare this adjusted expense percentage to your projected replacement ratio to see if you are on track to have enough retirement income.