New retirees often rave about the pleasure of ditching their alarm clocks and filling their days with activities they find fulfilling. But if they’re honest, most new retirees find the financial aspect of the transition into retirement a bit jarring.

While retirees are often advised to anticipate spending 75% to 80% of their working income in retirement, an article by David Blanchett, formerly of Morningstar and now at PGIM, found that higher-income, higher-saving households may need . may need only 60% or even less of their pre-retirement income during retirement, while low-income, low-saving households may need close to 90%.

Estimating your actual income replacement needs can be difficult, so here are the basic steps to take when doing so:

Step 1: Find a realistic basis for your income

If you are close to retirement and want to maintain a standard of living in retirement similar to the one you had while working, it is reasonable to use your current salary as a basis. But if you’re younger – say, in your 40s – it may be wise to increase your basic income for retirement planning purposes, as your current income may not reflect the amount you’ll want to spend when you retire.

Not only do you receive cost-of-living adjustments over the years, but career gains can also lead to a higher salary over time, and you may want to “replace” that in retirement. As Blanchett points out in her article, the average college-educated person will earn 50% more in retirement than they did at age 25. Increases in salary over time are less pronounced for people with lower levels of education.

Step 2: Subtract your savings rate

Take a look at what percentage of your salary you have saved or expect to save when you retire and subtract that from your base salary amount.

It is generally easier for higher-income individuals to save a larger percentage of their paycheck during their working years than for lower-income individuals. A household saving 20% ​​of its income will see its income replacement rate immediately drop to 80%, even without accounting for planned lifestyle changes such as downsizing homes.

If you’re several years into retirement, you can increase your savings rate as your income increases.

Step 3: Subtract tax deductions

Many people realize tax savings when they retire because they no longer pay Social Security or Medicare taxes. The savings tend to be more pronounced for higher-income workers than for lower-income workers. Wealthier households may see a larger percentage drop in taxes in retirement than lower-income households because they have more control over their taxable income because they are no longer earning a paycheck; The less they withdraw from their portfolio, the less tax they are subject to.

Step 4: Subtract expected housing cost reductions

Housing costs are another item that has the potential to change significantly in retirement. For example, do you have plans to retire mortgage-free? Or maybe you’re thinking of moving or downsizing in some way? While the main purpose of downsizing is to add home sale proceeds to your retirement kitty, it can have the beneficial effect of reducing property taxes and reducing expenses for insurance, utilities, and maintenance. As a senior homeowner, you may also qualify for a reduction in your property taxes, depending on where you live.

Step 5: Factor influencing lifestyle changes

Retirement planning guides often encourage retirees to also account for changes in other expenses, such as commuting, work attire, and eating out while at work or due to busy work schedules. For some households these changes may be minimal, but for others they may be more significant.

Don’t assume there will be a reduction in lifestyle expenses in retirement without crunching the numbers. A busy travel schedule or an expensive hobby or other expenses can offset cost reductions on items like food.

Step 6: Add higher health care costs

Health care is one of the important areas where retirees’ expenses are likely to increase. A recent Fidelity study showed that the average lifetime out-of-pocket health care expenses for a 65-year-old retiring today would be about $160,000, and that figure doesn’t even include long-term care expenses.

Higher health care costs later in life are a key factor in what Blanchett calls the “Retirement Spending Smile.” This is the tendency for household spending to be on the high side immediately after retirement, decline in mid-retirement, and then rise again toward the end of life as health care costs rise for some older adults. If you’re going without long-term care insurance, your household’s total health-related expenses may increase dramatically toward the end of your or your spouse’s life.

Step 7: Add the fudge factor

Working on each of these steps can get you closer to your true income replacement rate. At the same time, it’s helpful to approach this exercise knowing that there’s a lot you can’t predict about your future expenses. Wildcards like long-term care costs, random home repair bills, and providing assistance to adult children or parents can unexpectedly increase your financial expenses in retirement. The potential for these unexpected expenses requires you to push your own income replacement rate a little higher to allow some leeway in your planning.

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This article was provided to The Associated Press by investment research site Morningstar. Christine Benz is director of personal finance and retirement planning at Morningstar. For more personal finance content, go to:

Related Links:

Best Flexible Strategies for Retirement Income:

3 Hard Decisions for Every Retirement Plan: /3-hard-decisions-for-every-retirement-plan

Your Retirement Checklist Should Go Beyond Finances: /preparing-retirement-requires-more-than-financial-plan

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