Thursday, May 31, 2007

70 % Question

From time to time I run across references to 'the 70% of pre-retirement income being needed to maintain one's standard of living in retirement". I also see references to 'perhaps 50% is all that is needed'. I don't recall ever seeing the calculations and assumptions behind the 70% estimate but someone likely did it years ago. I expect there is some logical rationale behind this percentage estimate.

I wonder...did those calculations include "an equivalent income" from a home that is owned during retirement?

In many cases, the rent one would have to pay to replace one's home is not a small sum, and it should therefore be considered in the "How much do I need for retirement?" question.

When financial advisers are giving conservative advice to the general public the 70 % estimate may not be that far off the mark if one's home is included as part of the income. There may also be a bit of a safety factor in the 70% estimate.

For example, if one owns a $200,000 home, this "net worth component" could be sold and the money invested. It would provide perhaps $14,000 per year ($1,167/month) before tax at 7%.

2 comments:

George said...

I'm not sure if the "replacement ratio" calculations did, or should, include "income" from a home.

A house isn't a form of income unless you're renting some or part of it out - otherwise, it's an asset that tends to appreciate, and one that requires a certain amount of cash each year in maintenance.

If you're retired, a huge question involved in calculating a "replacement ratio" is whether you own a home, and whether the mortgage is paid off. Somebody who owns a house without a mortgage can live on a significantly smaller income than somebody carrying a mortgage debt or paying rent. The ongoing costs of having a home (property tax, utilities) are paltry compared to the cost of servicing a mortgage.

Somebody who is paying rent or a mortgage after retirement is much more likely to need 70% (or more) of their pre-retirement income. People with no debts are much more likely to live comfortably on 50%.

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