Current vs. retirement income: How much do I need?

NEW YORK (Money) -- Question: I don't understand the rule that you need 85 percent of your pre-retirement salary in retirement. After all, if you're contributing 15 percent to a 401(k) or other savings plan and you're paying Social Security and other taxes, you're already living on much less than 85 percent of your salary. And if you pay off your mortgage before retiring, I figure you're still ahead of the game if you shoot for 70 percent. What do you think? -Clifford, Orange, Conn.

Answer: First, I think there's no real agreement on what this rule is. I know some people say you need 70 percent of pre-retirement income after retiring, while others claim it's 80 percent, 85 percent or 90 percent.

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But whatever version of this rule you hear, I think you need to take it with a very large block of salt. Of course, that's true of all rules of thumb, whether it's the percentage of pre-retirement income you need, "the 4 percent rule" on withdrawing funds from your portfolio in retirement, the "save 10 percent for retirement rule" or any other benchmark.

After all, rules of thumb are shortcuts; they're solutions that are supposed to work for the "average" person. In this case, the percentages you hear can be traced back to the Retirement Income Replacement Ratio studies by Aon Consulting and Georgia State University.

Using data primarily from the Bureau of Labor Statistics' Consumer Expenditures Survey, every three years researchers calculate the percentage of their pre-retirement salary retirees need to maintain their standard of living. The 2007 survey is scheduled for release in November, but you can read the 2004 version by clicking here.

I should add that the study doesn't give a single percentage. It calculates a variety of percentages that range from 75 percent to 89 percent based on several factors, including one's pre-retirement income. But whatever figure is quoted, it's still based on an average for some group.

We're all individuals, however, and our specific situations probably won't mesh seamlessly with any average. Some of us wear down the magnetic strip on our credit cards from non-stop swiping; others among us are such committed savers that we make the ant in Aesop's fable seem profligate. Some people are adamant about going into retirement debt-free. Others are doing cash-out refis at 55. There's no way that any single figure, whether it's 85 percent, 70 percent or 95 percent, can be the right one for all of us.

And when you consider that retirement can be decades away and that even when you reach it you'll likely be living decades longer, it's unlikely that any of us can really pinpoint a number or percentage and expect it to be absolutely positively correct. All of which is to say that none of these figures are carved in sacred tablets that are handed down from the retirement-planning gods. They're estimates.

So where does that leave you for your retirement planning? After all, you do need some target, some sense of how much income you'll need in retirement so you have an idea of how large a nest egg you must accumulate. One thing you can do is try to get a more realistic percentage than just accepting whatever version of the replacement income rule you hear.

For example, if you go to Aon's report, you can find replacement ratios for different income levels. If you dig around a bit more, you can also make adjustments based on how much you save. You might also factor in what sort of retirement lifestyle you envision for yourself.

The larger you plan to live, the more income you'll need, and the more you'll have to save. Granted, this won't give you an accurate-to-the-tenth-decimal-point figure. But you should be able to come up with a percentage that in your judgment is reasonable. You can then plug this figure into our Retirement Planner or a similar calculator and get a sense of what you need to do to hit that target.

If all this is too much trouble, there's an easier route you can take. Researchers recently published a study in the Journal of Financial Planning that provided guidelines for how much you need to save for retirement based on your age and income. The percentages they provide assume you will want to replace 80 percent of your pre-retirement income, except - and this is important - that 80 percent is after deducting the amount you save for retirement.

So, for example, if you earn $80,000 a year and save $10,000, the researchers assumed you would need 80 percent of $70,000, or $56,000 in retirement. The idea is that you don't need to replace the dollars you're saving for retirement since they don't reflect our pre-retirement spending. You can read the study by clicking here (Table 2 is the one you want to read).

Or, if you just want a quick read on how much you should be saving given your age, income and the amount you've already stashed away, you can check out the What You Need To Save Calculator we built based on the study.

Of course, the figure you'll get there isn't perfect either. It has a host of assumptions embedded in it, ranging from the return you'll earn on your investments, to the expected inflation rate, to the fact that you'll want only 80 percent of your pre-retirement salary after deducting savings. If you feel you'll need a higher percentage of income - maybe after all those years of savings you want to splurge a bit - then you'll have to increase the amount our calculator suggests you save.

As you get closer to retirement - say, within five or 10 years - a clear picture should begin to emerge of what expenses you'll actually face in retirement. At that point, you can start factoring in actual estimates of your retirement spending into your planning. The more detailed and accurate the estimates, the better the sense you'll have of how large a nest egg you're likely to have and how long it's likely to support you.

You can work out these estimates on your own or you could sit down with a planner or you could go to an online calculator such as Fidelity's Retirement Income Planner, which has an interactive retirement budgeting worksheet that allows you to plug in expenses in 49 categories, make adjustments for ones that may expire during retirement (such as your mortgage) and even apply different rates of inflation for different expenses. (The calculator is free, but if you're not a Fidelity customer, you'll have to register to use it.)

One final thing to keep in mind. Retirement planning isn't something you do one time and then assume you're set for the next 20 or 30 years. Too many things can change. Your investments may do better or worse than you project. Your savings habits may improve, or a job layoff might force you to dip into savings. You may want to retire earlier than you originally intended - or you may decide you want to ditch your current career and start a new one in retirement.

All of these factors and more can affect how much you'll need to retire comfortably or, indeed, whether you're ready to retire at all. So go over your retirement plans periodically to monitor your progress, to see if there are problem areas you need to address and to be sure the assumptions you're making still apply.

How often should you do this? I'd say about once a year. But please consider that a suggestion, not a rule of thumb.