Increase Replacement Ratio from 50% to Over 80%

In an earlier blog I reported on the recent study by the Pew Charitable Trust, which suggested that Gen-Xers (born between 1966 and 1985) were hit hardest by the Great Recession. I discussed that study with several radio hosts, including Jiggy Jaguar.

While I want to avoid the challenge of “dueling analyses”, I found the results from the study intuitively too pessimistic, and decided to test that result using our Savings2Income (S2I) retirement planning tool.

One of the key tenets of our S2I planning method is focusing on Spendable Income, which (a) before retirement is wages less taxes and contributions to retirement savings, and (b) after retirement is income from Social Security, any pension, annuity, and wages from any part-time work less taxes. The S2I goal is to create a customized Plan for Retirement Income that yields the highest Secure Income Ratio (SIR) – the relationship between before and after retirement Spendable Income.

Rather than looking at a whole range of individuals, we looked at a hypothetical Gen-X couple, both age 45 and working, with $75,000 of savings, and wages of $70,000 per year. We found that we could develop higher SIRs than the 50% in the Pew study – in fact above 80% – if our Gen-X couple did the following:

  1. Set aside 9% of wages in retirement accounts up until retirement, and benefit from a 3% employer match.
  2. Work part-time from 66 to 70 earning 50% of wages before age 66.
  3. Delay Social Security election to age 70.

There are, of course, challenges to achieving the plan, such as:

Can they afford to and have the discipline to set aside 9% of wages into savings year after year?

Will they be healthy enough to continue working after 66, and will work be available for them after age 66?

Will the economic assumptions as to returns, interest rates and inflation be achieved?

On the other hand, there are a few escape valves: downsizing and lowering expenses in retirement; saving at even higher rate in, say, the last 10 years before retirement; reducing expenses in retirement after one spouse passes away; and inheriting any legacy from parents or grandparents. However, there is also the potential issue of increased medical expenses and the need for long term care.

One radio host said that I’m one of the more optimistic financial guests he’s had on his show. However, without that optimism, hopefully not misplaced, the outlook might be pretty dreary for average Gen-Xers.