Replacement Ratio

A Replacement Ratio is a person’s gross income after retirement, divided by his or her gross income before retirement. For example, assume someone earns $60,000 per year before retirement. Further, assume he or she retires and receives $45,000 of Social Security and other retirement income. This person’s replacement ratio is 75 percent ($45,000/$60,000).

Typically, a person needs less gross income after retiring, primarily due to several factors:

• Income taxes go down after retirement. This is because extra deductions are available for those over age 65, and taxable income usually decreases at retirement.
• Social Security taxes (FICA deductions from wages) end completely at retirement.
• Social Security benefits are partially or fully taxfree. This reduces taxable income and, therefore, the amount of income needed to pay taxes.
• Other forms of retirement income, like pensions, are often are exempt from taxation by states
• Saving for retirement is no longer needed.