Retirement Replacement Ratio: Key to Retirement Planning

Retirement planning can be incredibly complex - or not. We believe that many of the retirement planning guides and tools made available to the average person focus far too much on intricate details of retirement planning - to the point that many people just walk away and dismiss thinking about retirement planning until another day. This, of course, is a huge mistake since time and the power of compound interest are the most important allies we have to help achieve a financially successful retirement.

So, our simplified approach to retirement planning focuses on just a single concept: your retirement replacement ratio (RRR). The notion of RRR is very simple:

1. when you retire, your regular bi-weekly or monthly paycheck will stop;
2. you will need to have alternate income sources at the ready to replace some (or all) of the working income you lost;
3. your RRR (retirement replacement ratio) is simply the portion (ratio) of working income that you plan on replacing with social security, income from your 401k, part-time employment or other sources

If you are accustomed to taking home $1,000 each week while working, your retirement planning efforts should focus on assessing what ratio of this pre-retirement income you feel you will need in retirement.

So, what should your RRR be? Again, this analysis can be made complex to the point of becoming a doctoral dissertation, if you desire. But from our viewpoint of wanting to focus on simple yet effective retirement planning, we think most people will be adequately served by targeting a minimum retirement replacement ratio equal to 75% of pre-retirement income. In the example above, the retirement plan would aim for weekly retirement income of $750 ($1,000 x .75). This is in line with the analysis of the General Accounting Office (GAO):

There is little consensus about how much constitutes “enough” savings to have going into retirement...We may define retirement income adequacy relative to a standard of minimum needs, such as the poverty rate, or to the consumption spending that households experienced during working years. Some economists and financial advisors consider retirement income adequate if the ratio of retirement income to pre-retirement income—or replacement rate—is between 65 and 85 percent. Retirees may not need 100 percent of pre-retirement income to maintain living standards for several reasons. Retirees will no longer need to save for retirement, retirees’ payroll and income tax liability will likely fall, work expenses will no longer be required, and mortgages and children’s education and other costs may have been paid off.

Having an idea of your retirement replacement ratio is the foundation of effective retirement planning. In future posts, we will discuss each of the income pieces to be considered in planning to achieve a 75% RRR.