This post is another in a series about the dangers of using rules of thumb as a basis for your financial plan. As I’ve mentioned before, many of these so-called rules were only marginally true and only in limited circumstances. And, even if they were true 30 years ago, many of them are outdated. The notion that retirees’ expenses will be 70% of their pre-retirement expenses is one of those outdated ideas.
I’m not completely sure where this idea originated. I remember hearing it in the 90s and I’ve spoken with people who say they first heard it in the 80s. I suspect it came about when planning for retirement became more important. Companies started cutting pension plans in favor of 401k plans which cost the companies far less and put the responsibility of saving for retirement on the employees.
Assuming that the idea did originate in the 80s, think about all the things that have changed since then. The world in general and the workplace in particular. Here are just a few examples.
Thirty years ago, expenses for suits and dry cleaning were significant budget items. Most white-collar workers wore suits to work which were expensive and required expensive dry cleaning. We don’t see as much of this today.
Interest rates were sky-high in the 80s. Wouldn’t you love to be able to get the 8.0% yield on a 1 year CD like you could in 1985? On the other hand, the average annual 30 year fixed mortgage rate for 1985 was 11.85%. Today, the average rate on a new 30-year fixed mortgage is around 4.5%.
Three decades ago most people included daily commuting costs in their living expenses while today many people have the option to work from home for at least part of their work week. Fuel-efficient cars were becoming more available after the gas-guzzlers of the 60s and 70s, but they weren’t yet as efficient as the cars today. Today it’s even possible to save on dining expenses by eating at home on those work-at-home days.
The gist here is that expenses related to working years were higher back then. We’ve already seen some of the reduction of those expenses in our everyday lives in work-related areas like lower clothing bills, lower commuting expenses and lower interest expenses. If a worker is still paying a mortgage close to or at retirement age, their interest expense is already lower than it would have been back then. So, the baseline expenses that people consider are already lower – we’re not at 100% of the pre-retirement expenses from the 80s to start with. It might have been one thing to consider the full level of living expenses that you might have had in 1985 and reduce it to 70%. But today’s expenses have already been reduced by items like these.
In addition to a different starting point, we have a different ending point when it comes to expenses in retirement today. For example, according to the Federal Reserve’s Survey of Consumer Finances, in 1989, 21 percent of households headed by people aged 65 to 74 had a mortgage. In 2018, 35% percent of households headed by people aged 65 to 74 had a mortgage. This means that more people are still paying mortgages in their retirement years. Then think about utilities. Watching over-the-air TV was free. Many people had cable but not everyone did and it wasn’t considered a necessary expense in retirement. Even if you’re a cord-cutter today, odds are you replaced your cable subscription with some other streaming service which comes with a monthly fee. And then there’s internet service. Internet didn’t even exist for the general public in the 1980s. Now, add in smartphones which have their own plans not to mention the cost of the phones themselves. These are expenses that wouldn’t have been considered in a three-decades-old rule-of-thumb.
The result is that overall, 30 years ago the pre-retirement expenses were higher and the post-retirement expenses were lower. A reduction of 30% may have made sense.
Today, in my experience, people actually spend more in retirement than they did when they were working. More retirees travel and some of those trips are expensive. As I mentioned above, many are still paying a mortgage – as well as student loans for their children’s college education. Whether due to medical advances or better self-care, I find that retirees are more active and have more time to be active. That may come with costs like greens fees and club memberships. And this doesn’t take into account healthcare insurance or medical expenses. Three decades ago far more companies offered retiree health insurance. That benefit is rarely seen today so retirees will be covering more of their medical and healthcare premium expenses.
Why is this important? I see many people risk their retirement lifestyle because they work on outdated assumptions. When parents calculate how much they can pay for college, I often see them reduce their retirement savings to divert cash flow to college educations for their kids. And often they believe that they’ll still be fine because income from their retirement savings would still cover 70% of their current expenses. In addition, they assume the same amount for expenses for the rest of their (estimated) life expectancy without considering the possibility of medical or long term care needs. They don’t take into account things that have changed in the last 30 years. And they don’t take into account how things may change in the next 30 years.
Don’t let this be you! Sit down and describe what you envision for retirement. Consider how often you would like to travel or play golf. Think about any medical conditions you already have and consider any conditions your parents developed as they aged. Then make a more-informed estimate of what your living expenses will really be. Don’t forget taxes. And then keep your more-informed estimate in mind when you make decisions about an appropriate level of saving for retirement today.