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Retirement Income Replacement: How Much Do You Need for Retirement?

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We get this question all the time here at Savology: “How do I know when I’ll be ready to retire?” It’s a complicated question, and there is no one-size-fits-all answer. Our hope is that by the end of this guide, you will have a better idea of how to answer that question for yourself.

From what we’ve seen, most people have never sat down and calculated how much they need to have saved to be able to retire. And, even if they have, their projections can be way off. This often leaves them in the uncomfortable position of choosing between a later retirement, running out of money early, or leaning on family members for support throughout retirement. According to a 2019 study by Northwestern Mutual, only 44% of Americans think they know how much they would need to retire comfortably. On top of that, 46% say they expect to work past the traditional retirement age of 65. We don’t want you to be in either of those boats unless it’s by choice.

In this guide, we’ll look at two different methods for calculating how much money you need to retire. Then, we’ll look at Savology’s approach to calculating your retirement income need as part of a digital financial plan.

Two methods of calculating your retirement savings need

There are generally two ways to calculate your retirement savings need. The first is by using a multiple of your income, and the second is by using a percentage of your income. Let’s break down those two methods.

Multiple of Your Income

What is the multiple method?

The multiple method is a great way to quickly get an idea of how much you need to have saved for retirement. The math is simple. Just take your current income and multiply it by your chosen multiple. Most proponents of this method recommend a multiple between 10 and 25. So, say your annual income is $100,000, and you’ve decided to use a multiple of 20. That means that to retire comfortably, you’ll need $2,000,000 saved by your retirement age. Easy, right?

However, with the simplicity of this method comes some limitations. Since it is just a flat multiple, it doesn’t directly account for factors that might uniquely affect you like inflation, income growth, social security, investment returns, and more.

What experts have to say about this method

Some financial experts say that having ten times your income in retirement savings by age 65 should be sufficient. Others, like Tony Robbins, say a multiple of 20 is more realistic. In his book Unshakeable: Your Financial Freedom Playbook, this is what he says: 

The next step of the retirement planning calculator is to multiply your income by twenty. This simple calculation will give you a rough idea of how much you will need to maintain your lifestyle through retirement.

Many other financial planners will tell you to multiply your annual income by 10 or even 15. But today, with such low returns on safe investments and with most people looking for financial certainty in uncertain times, that’s not realistic.

There are many opinions on which multiple to use. Even more recently, the 25X rule of retirement has become very popular.  Whether you need to use a multiple of 10 or 20 depends on your assumed investment returns and social security usage. The more conservative your assumptions are, the more you will need to have saved.

Percentage of Your Income

What is the percentage method?

The second way to calculate your retirement income need is by using a retirement income replacement percentage. The retirement income replacement percentage, or RIRP, is simply the percentage of your current income that you will be able to replace with savings during retirement. This calculation can be a little more involved. Still, it is generally more accurate because you can work in factors like investment return, inflation, and social security in addition to your income and age. 

The RIRP method is also easy to understand because all you have to worry about is one number. To determine that number, you just have to consider what kind of lifestyle you want to have during retirement. Different financial advisors and firms might have their own recommended percentages, but as a rule of thumb at Savology, we use the following percentages:

  • If you want a more simple, minimal lifestyle than now: 70%
  • If you want a similar lifestyle to now: 80%
  • If you want a more extravagant lifestyle than now: 100%

A common question that comes up at this point is “Why do I only need 80% income replacement if I want a similar lifestyle to now? Wouldn’t an 80% RIRP mean I’ll have less money in retirement?” It is true that with 80% income replacement, you will be living on less money in retirement than you do now. However, you will have far fewer expenses to worry about. 

Here are just a few examples of expenses you probably won’t have to worry about during retirement:

  • FICA tax, which includes social security and medicare
  • Saving for retirement
  • Mortgage, student loans, auto loans, or other debt payments

Altogether, these expenses take at least 20% of your current income, meaning that 80% income replacement will allow you to live a similar lifestyle in retirement.

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Savology has helped more than 40,000 households across the United States improve their financial well-being by providing comprehensive digital financial planning. Users can get started with our free financial planning or premium monthly planning memberships, allowing them to build a personalized financial plan, holistic report card, personalized action items, and more. In addition to our consumer-facing platform, we're helping employers across the country provide their employees with effective financial wellness benefits.

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A Note on Traveling and Splurging During Retirement

As you consider your ideal retirement lifestyle, you might decide you’re going to travel the world and drink champagne every night, so you need to shoot WAY higher than 80% income replacement. While many retirees do increase their spending on travel or splurge in other areas, this typically only happens during the first 10 to 15 years, before mobility becomes an issue. Don’t let that discourage you from shooting for a higher income replacement—more money in retirement is never a bad thing. However, know that if you have paid off your debts and you’ve managed your finances well over the years, you will still have a fair amount of wiggle room if you shoot for an 80% RIRP.

How to calculate your retirement savings need using the percentage method

To calculate how much retirement savings you’ll need using the RIRP method, all you need is your current annual household income, an idea of what kind of lifestyle you want to have during retirement, and your life expectancy. 

For example, say you are 40 years old in 2021. Your current annual household income is $100,000, and you want to retire when you’re 65 in the year 2046. Let’s also say that you want to have a similar lifestyle to the one you have now in retirement (80% RIRP). So, 80% of $100,000 gives you a target annual income replacement need of $80,000 in retirement, or $148,000 in 2046 dollars. To calculate your total retirement savings need, multiply your income replacement need by the number of years you will live in retirement. If you think you’ll live to be 86, that means $148k multiplied by 21 years. That gives you $3.1M as your total retirement savings need.

One of the best things about the percentage method is that it’s flexible. Decide you want a more extravagant lifestyle? Just switch out the percentage you’re using. Decide you want to retire later? Just switch out the number of years you will need savings. Decide you want to take other factors into account like social security, inflation, and investment return? You can work those into the calculation as needed. 

Calculating your retirement savings need can be complicated, and it can be overwhelming to see a million-dollar number and think, “how am I ever going to get there?” Savology makes it so much more accessible. By filling out a brief survey about your finances, you can get insight into your retirement outlook. We also give you recommendations and resources to help you reach your goals. Best of all, we do all the calculations for you and present everything in an ultra-digestible way.

 

Calculate your retirement age and retirement income with Savology

 

Savology’s Method

When you create a financial plan with Savology, we use the income replacement percentage method to calculate your retirement outlook, with some additional assumptions to ensure that your retirement is as accurate as we can get it from day one.  

Assumptions

Savology’s assumptions are relatively conservative when calculating your retirement outlook, balancing a simple presentation with a sophisticated calculation. The goal is to produce accurate and intuitive projections of your RIRP without you having to worry about creating your own assumptions. However, if you ever do want to customize your assumptions, you can do that in the Change Plan Assumptions Module. These are the assumptions Savology uses right out of the box:

  • Retirement Assets: 6% annual rate of return 
  • Other Assets: 3% annual rate of return*
  • Inflation: 2% annually**  
  • Retirement Assets After Retirement: 4% annual rate of return 

*This includes cash and other investment assets, which have varying degrees of returns.

**Inflation should always be top of mind with retirement calculations. The higher inflation rises, the less your dollar stretches. Inflation is currently at a historical low—under 2% per year over the last ten years. In today’s economy, we are assuming that this trend of low inflation will continue. The inflation rate has continued to decrease each decade since 1970, and we don’t see this trend changing any time soon.

Approach to Retirement Income Replacement Percentage

When you go through Savology’s survey, we will ask you to select which of the following lifestyles you want in retirement:  

  • A more simple, minimal lifestyle
  • About the same as now 
  • A more expensive lifestyle

As we mentioned earlier, the type of lifestyle you want will determine your target retirement income percentage. We use 70% for a more simple, minimal lifestyle, 80% for about the same as now, and 100% for a more expensive lifestyle.

As a side note, if you are under age 45 and believe your income is likely to increase significantly before retirement, then we suggest you select “a more expensive lifestyle” to account for your increased earnings.

Again, you can always further customize your RIRP goals if our base assumptions don’t work for you. 

Calculation Year by Year

At Savology, we know that if your savings rate is not where it should be today, you likely won’t get there by tomorrow, or next week, or even next month. For this reason, when we calculate your retirement outlook, we assume that if your current savings rate is lower than it should be, you will ramp up your savings rate over a few years, increasing by 1-2% each year until you are on track. This assumption makes our projections that much more accurate and, more importantly for you, attainable.

With a digital financial plan through Savology, we clearly show you the gap between your projected income replacement percentage and your target income replacement percentage. To calculate this, we start with how much we anticipate you will be withdrawing each year of retirement. From there, we take your income in the year you retire and multiply that number by your target income replacement percentage. We then adjust that number for inflation to a future dollar amount in the year of withdrawal. Then, we subtract your estimated social security, pensions, annuities, and life insurance. We can then calculate your projected income replacement percentage based on how much you have saved and how much we assume you will save according to your savings rate. From there, it is easy to turn the projected income amount into the estimated income replacement percentage. 

Additionally, we estimate your life span based on an actuarial life table and compare it to your desired retirement age. This estimate helps us determine how long you need to plan to have the money last.

Social Security Calculation

Recently, there has been a heated debate in the public sphere about whether people will get much of any social security in 30 or 40 years. In Savology’s retirement assumptions, we anticipate that social security will still be in place to some degree. After all, it is a social program, and social programs are tough to eliminate. Still, many experts say that the government could reduce social security by 20 to 30 percent for millennials based on projected population demographics. 

To account for lower social security for younger generations, we reduce the social security offset for everyone under 50 by 25 percent. We use the Social Security formulas provided directly from the Social Security website. However, there may be some real-world differences in the Social Security numbers depending on your actual earnings each year. 

Limitations of RIRP

One limitation of retirement income replacement percentage is that it doesn’t do well for someone with low income due to schooling or other unfortunate circumstances. It also doesn’t work as well for people who have many expenses paid for or financed and are able to live off lower incomes. For example, a college student that hasn’t started their career yet or someone still living with their parents. In these cases, you should consider using a different metric, like a flat dollar amount, when considering your savings rate and retirement needs. Savology does this by giving everyone a minimum income replacement need of at least 1.5 times the poverty line in retirement. This number comes out to be roughly $25,000 in today’s dollars. If you are making less than the 1.5x poverty threshold, we base the retirement section of your financial plan in Savology on this minimum standard of living. 

If you are currently in a tricky financial situation, be patient with yourself and your savings rate. Understand that you will likely not be on track to meet your retirement goal right now, and that is okay. Once things change and you start making more money, you can get on track if you stick to your financial plan. 

Conclusion

For most households, income replacement percentage is the single most important indicator for determining retirement readiness. It helps you to boil down everything surrounding your retirement outlook to one number and track your progress along the way. It is a powerful tool to help you understand whether or not you are on track for retirement. If you’re not on track, it can also help you identify what you need to do to get on track. If you want to know more about how you are doing, let us do the work for you with our financial planning software. You’ll be able to determine your RIRP and understand what you need to do to be ready for retirement in no time.

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Article Author:
Sam Jones, AFC

Sam Jones, AFC

Sam is an Accredited Financial Counselor® and has more than 5 years of experience in the financial services industry. Sam works as a financial planner at Vitality Capital Management. He recently graduated from Utah Valley University's Personal Financial Planning program. Sam is a CERTIFIED FINANCIAL PLANNER™, and is passionate about personal finances and helping individuals to reach their goals. Sam loves spending time with his family, boating, snowmobiling, and volunteering in the community.
Article Author:
Sam Jones, AFC

Sam Jones, AFC

Sam is an Accredited Financial Counselor® and has more than 5 years of experience in the financial services industry. Sam works as a financial planner at Vitality Capital Management. He recently graduated from Utah Valley University's Personal Financial Planning program. Sam is a CERTIFIED FINANCIAL PLANNER™, and is passionate about personal finances and helping individuals to reach their goals. Sam loves spending time with his family, boating, snowmobiling, and volunteering in the community.

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