Although the term retirement income replacement ratio sounds formidable, it’s actually an easily understood concept that doesn’t require any fancy math. The ratio helps you zero in on your retirement savings goal and periodically measure your progress as you move toward your target.

Will you need 60%, 75%, 90%, or even 100% of the income you have in your last year of work to maintain a desirable standard of living after you retire? The answer to this question is your income replacement ratio — the percentage of your preretirement earnings that will provide you with the same standard of living in retirement. For example, if your preretirement income is $50,000 but your income after retirement is $35,000, you have a replacement ratio of 70% ($35,000 divided by $50,000).

Setting the Foundation of Your Plan

Widely used by financial planners, replacement ratios are common elements of worksheets, online calculators, and computer software programs created to help individuals plan how they will finance their retirement years.

With the ratio, you can estimate how much income you will likely need for a comfortable retirement and how much money you need to save to supplement your expected sources of income — which may be some combination of Social Security, pension benefits, personal investments, and postretirement employment. If these income sources fall short of your goal, you can increase your rate of saving or take other actions to close the projected deficit, such as planning to reduce your standard of living or moving to a lower-cost locale in retirement.

What Research Tells Us

Opinions vary on the question of how much replacement income retirees need. One major study found that the majority of newly retired households were in good shape when income from traditional pensions, 401(k)s, IRAs, and other financial assets were added to Social Security benefits. Their replacement rates approximated the 65% to 75% of preretirement income that the authors considered adequate for middle-income retirees. However, the one-third of households without a pension or other assets earmarked for retirement did not fare as well, with replacement rates of 45% to 55%.1

Research also indicates that lower-income and higher-income households are likely to require higher-income replacement rates than middle-income households. According to one landmark analysis, replacement ratios average 89% for those with a preretirement income of $20,000 and 88% for those earning $250,000 but 75% for those earning $60,000 (see chart).2

Replacement Ratios at Different Income Levels
Replacement ratios peaked at 89% for a couple with annual preretirement income of $20,000. They declined to 75% for those earning $60,000 and increased to 88% for high-income households. Also note that Social Security replaces a much larger portion of preretirement income for lower-paid individuals than those with higher incomes.
Source: Employee Benefit Research Institute, EBRI Notes, September 2004 (most current data available). Assumes a family situation with one wage earner who retires at age 65 and has a spouse age 62.

Bottom line: Many people may need between 60% and 80% of their final working years’ income to maintain their lifestyle after retiring.

Why don’t they need 100% of their working income? Lower taxes may be one reason. When a person is no longer employed, there are no Social Security payroll taxes to pay. Federal income taxes are usually lower because Social Security benefits are either partially or fully tax free for many retirees, and extra deductions are available for people over age 65. In addition, many people no longer need to save for retirement, and those who have paid off debts before retiring or eliminated work-related expenses, such as commuting costs, also have a greater share of their income available for spending.

However, one increasingly important curveball is the rising cost of medical care. Already, medical care has been taking a bigger bite out of retiree budgets as health care expenses have risen at a faster pace than overall inflation; many employers have reduced or eliminated medical coverage for retired employees; and life expectancy has lengthened. In addition, retirees have faced higher contributions for Medicare benefits and increased premiums for Medicare supplemental insurance policies.

The Outlook for Future Retirees

While research indicates that recent retirees and those nearing retirement tend to have adequate replacement income, the situation may not be so favorable in the future due to the declining availability of traditional pensions. For example, the increasing financial strains on Social Security caused by the nation’s aging population may lead Congress to alter the system at some point in the future, perhaps reducing Social Security benefits or increasing the age of eligibility. As a result of these trends, future retirees may have to rely more on income from personal savings and investments than today’s retirees.

What You Can Do

Putting yourself on track to a secure retirement requires a few calculations, which can be accomplished relatively easily by using a retirement planning worksheet or calculator available on the Internet, from financial advisors, and retirement plan providers. For example, the Ballpark Estimate at takes you through the steps so you see approximately how much you may need to save to finance your later years.

Calculators and worksheets typically factor in a replacement income ratio, along with assumptions about future inflation rates, longevity, and the growth rate of retirement savings. (As you complete these calculations, bear in mind that such assumptions can’t be guaranteed.) Calculators and worksheets also usually take into account information about your current retirement account balances, rate of savings, and anticipated benefits from outside sources including Social Security and pensions.

In addition to setting your initial savings target, it’s a good idea to go back and run the calculations every year or so to keep tabs on how you are doing and to adjust your plan if your goal changes.

While ballpark estimates may be adequate when retirement is a long way off, more accurate planning is advisable as the actual date approaches. If you don’t feel up to the task of refining the numbers, consult a financial advisor. He or she can help you develop detailed income and expense projections, review your assumptions about inflation and future returns from savings and investments, and determine a prudent level of withdrawals from your assets.

Points to Remember

  1. Retirement income replacement ratios compare preretirement and postretirement income with the aim of determining how much income will be needed to maintain a comfortable retirement. They are calculated by dividing expected retirement income by preretirement income.
  2. Because of reduced taxes and other factors, many retirees may need a replacement income ratio of 60% to 80% to maintain the same standard of living they had before they stopped working.
  3. Determining a replacement income ratio is the first step in setting a retirement savings goal to make up for any shortfall in income needed for retirement.
  4. Ballpark estimates of retirement expenses and income can be used in long-range retirement planning, more accurate and detailed calculations should be undertaken when retirement is close at hand.
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1Source: Center for Retirement Research at Boston College.
2Source: Employee Benefit Research Institute, September 2004 (most current data available).

1Withdrawals from annuities before age 59½ are taxed as ordinary income and may be subject to a 10% federal penalty tax. In addition, the issuing insurance company may also have its own set of surrender charges for withdrawals taken during the initial years of the contract.

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