Do you really need 130% of your salary in retirement?

A recent Wall Street Journal article's claims are not supported by Morningstar research.

Ruth Saldanha 25 September, 2018 | 5:00PM

Earlier this month, a Wall Street Journal article claimed that retirees will need 130% of their pre-retirement salary in retirement. The reason, according to the authors, is that they have 40 extra hours each week in which to spend, and employer perks like coffee, phone bills and laptops are no longer taken care of.

But is this true?

Not really, according to Morningstar's director of retirement research David Blanchett. The article, he says, doesn't really jive with empirical evidence on spending in retirement. Generally speaking, most people believe they need between 70% to 80% of their pre-retirement income in retirement.

"While a replacement rate between 70% and 80% may be a reasonable starting place for many households, when we modelled actual spending patterns over a couple's life expectancy, rather than a fixed 30-year period, the data shows that many retirees may need approximately 20% less in savings than the common assumptions would indicate," Blanchett says. Which means you could look at a spend rate of even less than 70%.

Though it is true that some employer-provided benefits, including the aforementioned coffee, laptop and phone bills, will vanish upon retirement, it is also equally true that several expenses also reduce. This includes commute expenses and work wardrobe expenses. However, one major expense that reduces is often overlooked: saving for retirement.

"Let's say someone is making $100,000, and they are saving 20% of their salary. They have an income need in retirement that's just $80,000 because they have been a heavy saver in the years leading up to retirement. A household saving 20% of its income will see its income-replacement rate drop to 80% right out of the box, even without factoring in any planned lifestyle changes, such as downsizing homes," says Christine Benz, Morningstar's director of personal finance.

Chances are, you will also end up saving on taxes. Because you're no longer paying into the Canada/Quebec Pension Plan, many people end up realizing tax savings when they retire.

These savings tend to be more pronounced for higher-income workers than lower-income ones. More affluent households may see a bigger percentage drop in taxes in retirement because they have greater control over their taxable income now that they're no longer earning a paycheque; the less they pull from their portfolios, the less they're taxed on. Moreover, even as both types of households are drawing income from their portfolios to fund in-retirement living expenses, the higher-income household is apt to be able to have more levers available to keep taxes down--for example, drawing just enough assets from RRIFs and taxable accounts to stay within the lowest tax bracket.

Having said that, it is important to note that what you spend will depend very much on what you want your retirement to look like.

The retirement consumption path, or "spending curve," will be a function of the household-specific consumption basket as well as total consumption and funding levels, Blanchett notes. Households that consumed less and had high savings rates during the working years tend to have real increases in spending through retirement as retirees adjust their habits, while households with higher levels of pre-retirement consumption and lower funding ratios tend to see significant decreases.

"For some retirees, especially in the early years of retirement when retirees are feeling good, they maybe have some pent-up demand for expensive or elaborate travel, and then discretionary expenses can start to tick up. Other retirees might say, you know what, what I really want to do is take advantage of this time. Maybe I like riding my bike to the library most of all or cooking at home or doing some of the things that I haven't been able to do because I have been too busy working. Really just taking a step back and thinking about the direction of your discretionary expenses, I think that's a really helpful step as you formulate a vision for your retirement spending," says Benz. You can read up more on steps to estimate your in-retirement cash flow needs here.

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Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca