How much money do you need for retirement? It all depends on your lifestyle. If you plan to travel extensively and live a lavish lifestyle, you need a lot. If your retirement plans are simple and you plan to stay close to home, you don’t need as much. In the world of in retirement planning, the 4 Percent Rule for Retirement Withdrawals and the 80 20 Rule of Thumb are held out as the gold standards, but should they be?

The 80 20 Rule is a commonly-used rule of thumb for retirement planning. It's used by banks and financial institutions that hold the retirement accounts of millions of Americans. It’s also used by financial advisors and free online retirement calculators.

What is the 80 20 Rule?

The 80 20 Rule is the theory that you should save enough for retirement to replace 80 percent of your pre-retirement gross income. Gross income is your topline salary or wages; i.e., the amount before anything is withheld from your paycheck.

The 80 20 Rule is based on two facts and three assumptions:

TWO FACTS:

1. Once you retire, you no longer have payroll taxes.
2. Once you retire, you no longer need to save for retirement.

THREE ASSUMPTIONS:

1. You will spend less money on everyday items after you retire.
2. You own your home and the mortgage will be paid off by the time you retire.
3. Your income taxes will be lower in retirement.

Facts and Assumptions

If you look closely at the paystub you receive from your employer, you will see FICA, MED and OASDI listed beside corresponding amounts withheld from your paycheck. FICA stands for Federal Insurance Contributions Act, MED is short for Medicare, and OASDI stands for Old Age, Survivor, and Disability Insurance. These payroll taxes will no longer be withheld from your paycheck when you retire because you won’t have a paycheck. Regarding the second fact, it should come as no surprise that once you retire you will no longer need to save for retirement.

That takes care of the two facts. The three assumptions require a bit more discussion. I almost said the devil is in the details. I hate that overused phrase. Same with six on the one hand and half dozen on the other, and at the end of the day. In fact, here’s a list of things that no one should say ever for any reason:

Apples-to-apples
At the end of the day
Bang for the buck
Beating a dead horse
Big ask
Big get
Come to Jesus meeting
Deep dive
Dog and pony show
Ducks in a row
Elephant in the room
Epic
Game changer
Get the ball rolling
I'm just saying
I'm not going to lie
Knock yourself out
Low-hanging fruit
No brainer
Not rocket science
Par for the course
Pick your brain
So…
Something, something
There’s no there there
To be perfectly honest with you
Touch base
Train wreck
Win-win

Why can’t we just speak English? Don’t you feel sorry for anyone coming to this country and trying to understand us? How can they possibly know what’s going on? Can you imagine the conversation after the first day on the job? 

“Oh honey, it's been a long day. This one guy wanted to take a deep dive and touch base. I’m not sure what that means but I don’t like the sound of it. If I won’t let him, I think he's going to drill down and pick my brain."

"Somebody was talking about the devil and synergy, then someone invited me to come to the Jesus meeting. I’m glad I missed the dog and pony show because I’m pretty sure they were beating a dead horse. Mostly they just lied to me. Once in a while someone would say, ‘To be perfectly honest with you…’ then they would finally tell me the truth. Maybe we should go back home. Oh, did you hear about the train wreck?"

The First 80 20 Rule Assumption

The first 80 20 Rule assumption, that you will spend less money on everyday things after you retire, is based on a number of factors. Your daily commute will be eliminated, there may be less going out for lunch, fewer dry-cleaning bills, and less clothing purchases. Some couples pare down to one car in retirement. All of that may be true, but there are other costs that may increase, such as travel, hobbies, and healthcare.

The Second 80 20 Rule Assumption

The second assumption, that you own your home and the mortgage will be paid in full by the time you retire, is also questionable. Some people get a late start and do not purchase their first home until they are middle-aged. Some folks keep trading up for a bigger home, always with a 30-year mortgage. Other people take out a second mortgage. A study by the Consumer Financial Protection Bureau found that one-third of Americans age 65 and older still have a mortgage, and the average balance is $79,000. Then there are those who never purchase a home, they rent all their lives.

The Third 80 20 Rule Assumption

The third assumption, that your taxes will be lower, seems logical on its face. After all, you will no longer be working. But you still need income to meet your living expenses. Where will it come from? Retirement account distributions and Social Security retirement benefits, much of which is taxable. That includes traditional 401(k)s, traditional IRAs, pensions, and most annuities. Income that is not taxed includes distributions from after-tax accounts such as Roth IRAs, Roth 401(k)s, reverse mortgage proceeds, and the first $250,000 of profit from the sale of your home ($500,000 for married couples).

The primary goal of retirement planning for most people is to bring the lifestyle they enjoyed while working into retirement. In order to do that, you will need essentially the same amount of income in retirement as you earned while working, less payroll taxes and retirement savings. The fact is, your tax rate in retirement may be the same as it was when you were working.

Retirement Rules of Thumb

All three of the assumptions used in the 80 20 Rule are highly subjective. The rule’s applicability to your situation depends on your particular set of circumstances. We haven’t even talked about retirement age or life expectancy. Recall that the 80 20 Rule is defined as having enough retirement savings to replace 80 percent of your pre-retirement gross income. For how long? Wouldn’t that be important? If someone retires at 55 and lives to 95, would they not need roughly four times as much savings as someone who retires at 67 and only lives to 77?

Retirement rules of thumb are a dumpster fire. The very notion that you should plan your retirement with a rule of thumb is preposterous. I would encourage you to leave that nonsense behind and take the time to develop a realistic retirement plan. 

The best way to plan for retirement is to hire a financial advisor or avail yourself to sophisticated modeling software. Programs like Eggstack analyze your unique situation and provide realistic guidance on how much to save. Eggstack takes into account all the things we’ve touched on here plus other factors such as when to start taking Social Security, retirement age, return on investment, inflation, and many others. It’s your retirement and you’re the one who’s going to be living it, shouldn’t you be the one planning it? 

Photo credit: Pixabay

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