Percentage Of Current Income Needed In Retirement

A common rule of thumb used by advisors is that you need 70% of your current income after retirement. Unlike most rules of thumb, this one is nearly useless. The number varies a great deal. Some people might actually need 100% or more of their current income. But for most of us doctors, the number is probably much less. Let me explain.

First, we pay a lot more in taxes than the typical person.  My tax burden so far this year (not counting property or sales taxes) is about 25% of my gross income.  That includes federal income tax, state income tax, social security, and medicare tax.  A couple of years ago when I was in the military, but still making a six figure salary, my tax burden was less than half that.  One year it was something like 6%.  Your tax burden is likely to be FAR lower in retirement.  You won’t be paying social security or medicare tax.  You might move to a state without a state income tax, and in many states some types of retirement income aren’t taxed at all, such as capital gains or pensions.  Best of all, your federal income tax is likely to be dramatically lower.  You’re probably in the 28% or 33% bracket now.  In retirement, you may not get out of the 15% bracket.  If spending from a taxable account, you’ll only have to pay capital gains and/or dividend rates (currently 15%), and even that you only have to pay on earnings.  If spending from a Roth account, no taxes will be owed at all.  Even if spending from a 401K or traditional IRA, you still don’t pay taxes on the first $11,600 you withdraw (married filing jointly), and the next $17,000 is taxed at 10%.  You get to withdraw another $52,000 at the 15% rate.  So your first $80,600 is only taxed at 11.8%.  Imagine pulling $80K from your IRA, $40K from your Roth IRA, and $30K from your taxable account (with a basis of $15K).  Your effective tax rate would be 7.7% on an income of $150,000.

Second, you don’t have to save for retirement when you are retired.  If you’re putting away 20% of your income as I’ve recommended during your career, well, that’s 20% you no longer need to generate in retirement.

Third, once you have enough money to retire, you get to ditch the life insurance and disability insurance.  For many doctors, this is as much as 5-6% of their income.

Fourth, you’re likely to have paid off your mortgage before retirement.  That’s probably ~15-20% of your current income.

Fifth, once you retire you should no longer be feeding, clothing, entertaining, and housing the kids.  We spend far more on clothing for our children than we do for ourselves, and the amount they cost us seems to go up each year.  Even if you’re planning to help with college, that expense will probably be past or nearly past by the time you retire.  Many people even choose to downsize their house.  Who needs four bedrooms with only two people?  This not only may provide a windfall to the nest egg, but saves on maintenance, insurance, utilities and tax costs for the house.

Sixth, health care isn’t as much a concern for us as it is for most Americans.  We don’t need as much because we are a little smarter (I hope) about when we seek care.  We get a fair amount of care for free or a discounted rate, as we can either do it ourselves or we receive professional courtesy.  Most importantly, most of us have been paying for our health care for decades already as we’re usually owners of our practice or partners in our group.  A typical American employee has a big shift at retirement.  The company has been paying the health insurance premiums, and now they’re not.  Even as early retirees, we don’t have that same issue.  Of course, at age 65 Medicare kicks in and helps out with this one as well.

Seventh, social security isn’t going anywhere.  It will be modified in one or more ways, but the program is still going to exist.  It is too popular not to.  As high earners, we’ll qualify for significant social security benefits, and our spouses will qualify for 50% of our benefit.  If I were retiring today this would be a benefit close to $36000 a year.  That’s not insignificant.  Even with a lot of other retirement income, only 85% of that benefit is taxable, providing another tax break. Yes, you may not get this until age 70 or so, so early retirees need to have a little extra saved for the first few yeasr, but even so, this is a huge benefit even for high earners.

Eighth, job-related expenses are going to go down.  You’ll spend less money commuting, and might even be able to cut back from 2 (or 3, or 4) cars to 1.  Not all of us wear pajamas to work, so you might save some on professional attire.  You’re likely paying your own CME expenses, at least indirectly, and that expense should be gone.

Ninth, many docs give a significant amount of money to charity as a percentage of their income, a tithe if you will.  A tithe on half the income is only half as much money.

Yes, some costs are probably going to go up.  With more time you’ll probably travel more.  Like most Americans you’ll spend more on health care than you do now.  You might even still be providing some support for children.  But overall, there is likely to be a huge reduction in your required income once you retire.  Let’s look at the math.

Take your current income, let’s say $200,000.

Subtract out 20% for taxes and 20% for retirement and you’re down to $120,000.

Subtract out 5% for insurance, 5% for child-related costs, and 15% for your mortgage.  You’re now down to $70,000.

Subtract out another 1% for job related expenses, 2% for reduced charitable contributions, and 1% for reduced housing expenses.  You’re down to $62,000.

Add back in say 10% for increased travel costs and 5% for increased health care costs.  This moves us up to $92,000.

Subtract out $36,000 for social security and that leaves us at $56,000, or 28% of our current income.

Finally some good news in personal finance.  Your expenses are not just likely to go down in retirement, they are likely to go down DRAMATICALLY.  Even if I’m off by 50%, you’re still not going to need 70% of your income replaced.

How big does the physician in the example need his nest egg to be before retirement?  Using the 4% rule, $56,000 per year, adjusted for inflation, can be provided by a nest egg of $1.4 Million.  How long will it take for him to reach that goal if he saves 20% of his $200K income a year and gets a return of 5% real on it?  Around 21 years.

Now, it’s important that you run the numbers for yourself, using your expenses and your desired retirement lifestyle.  But I think if you do you’ll be pleasantly surprised.  Save money consistently, invest it wisely, and a comfortable retirement is well within reach.