When should you consider your income replacement options? Hint: Well before you retire. How you save for retirement now and how much you intend to spend in the future are two driving factors of your personal income replacement rate planning.

Transitioning from your working life to retirement is a challenge because suddenly your income disappears. We get questions on this subject often from people nearing retirement: 

• “Where will my income come from after I retire from work or sell my business?”

• “How much income will I need in retirement compared to pre-retirement?”

• “Can my investments sustain me through retirement at my current income?”

You may be familiar with the income replacement ratio, or the 80% rule if you’ve ever sought advice for how to save for your retirement. This theory aims to set you up for a secure retirement, replacing approximately 80% of your pre-retirement paycheck with portfolio withdrawals, Social Security, pensions, and other income sources. If you’re nearing retirement, you may want to abandon the idea of the 80% rule altogether. Instead, focus on calculating how much you’re likely to spend in retirement in order to gauge a more accurate income replacement goal. Our experienced professionals at Dodds Wealth Management Group are here to help you plan and prepare for your retirement.

Income Replacement Rates

An income replacement ratio is a calculation of your gross income after retirement, divided by your gross income before retirement. Your income replacement ratio is what you will need annually in order to maintain your current livelihood after retirement. For instance, if your pre-retirement income is $250,000, but your income after retirement is $240,000, then your income replacement ratio is 94%. Determining your income replacement ratio should take into account your expected income sources, budget and what percent of your retirement savings are taxable. We will help you create a comprehensive retirement plan which takes into account the income replacement ratio you would like to have throughout your retirement.

How much Income Do I Need to Replace?

The first thing you need to review when it comes to income replacement is your cash flow needs. We recommend our clients put their current expenses into three buckets:

• Core expenses like medical care or housing

• Discretionary expenses like dining out or entertainment

• Larger goals like travel or funding grandchildren’s educations

When you have grouped your expenses into buckets, it’s easier to identify activities that will continue in retirement (mortgage payments) vs. those you can discontinue (dry-cleaning work clothes). Understanding your cash flow needs in retirement will give you clarity and insight into how much money you will need to save and whether you will need to look for additional supplemental income to meet your needs. For more information about building a plan and income replacement advice, call or contact us at Dodds Wealth Management Group today.

Income Replacement Sources

In retirement, people have access to several sources of income. Typically, people rely on payments from Social Security, distributions from retirement funds (401Ks and IRAs), and distributions from taxable investment accounts. Other income replacement sources could include defined benefit pensions through prior employers or privately-owned annuities. Your income from some sources will be stable, for example Social Security, pensions and annuities, while income from your investment accounts might vary each year. An experienced advisor should be able to show you how you will pull income from different sources over time. 

Learn more about your income replacement options and prepare to maintain your current livelihood when you retire or have other life events that require you to replace or supplement your income. Call us at Dodds Wealth Management Group and speak to our financial professionals today! Our Denver phone number is 303-539-3900 and our Colorado Springs number is 719-260-9200.

Andrew T. Dodds, CFP ® - Founder and Wealth Advisor

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.