Why Most Financial Advisers Are Wrong

From my earliest financial recollections, I have heard multiple times that in order to retire, you must be able to passively replace 80% of your pre-retirement income.

The problem with this advice is that it is simply wrong.

The “80 percent rule” as it is sometime called, makes some very errant assumptions, and I believe it promotes an attitude of ‘spend it if you got it.’ It assumes that before you retire, you are spending everything that you earn, and that your spending will only slightly curtail when you leave the workforce.

However, if you are truly spending everything you make while working, you will actually never accomplish retirement because you will have saved nothing (If Income – Expenses = 0, then your savings is $0.00 per month.)

Also, it assumes that the 20% decrease in spending comes mainly from not having a mortgage payment in retirement. The problem with this idea is that it is not uncommon for people to spend 25-30% on housing costs. If they pay off their mortgage, their budget is reduced by up to 25-30%, thereby reducing the amount they need in retirement. (I understand that taxes and insurance continue for the life of the homeowner, but those don’t always make up a full third of the mortgage payment.)

In addition to the mortgage payoff, once we are retired we no longer need to save a portion of our income for retirement. Since many people shoot for 10-15% of salary saved for retirement (we know we should aim for 50+%, but let’s just play this safe), we can reduce retirement need even further.

Commuting is a huge expense for many people during their working years, costing the average American nearly $2600 per year. That expense disappears in retirement.

Let’s also consider taxes. Capital gains taxes start at just over $75,000 for a married couple filing jointly. So if you are retired, making and withdrawing only passive income under $75k per year, you will pay no federal income tax. That is a huge savings in retirement, since most people will pay more than 15-20% of their income in state and federal taxes.

If we assume a 25% reduction in spending since the mortgage is paid off, plus the 10% reduction due to retirement savings, plus reduced commuting costs and taxes, we can actually assume that in retirement we will only need to replace 50% or less of our pre-retirement income. (That is not even including the other savings of not having to eat out as often or fund a business wardrobe among other working expenses.)

As a bonus, if we subtract the student loan debt that many of us high-earners have to pay each month, that retirement income goal may actually be closer to 40% of current income. This 40% goal should make retirement feel a little more attainable.