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Breaking Down The 45 Percent Rule Thumbnail

Breaking Down The 45 Percent Rule

Insights Retirement Planning Social Security Financial Planning

Today we look at one of Fidelity’s Four Rules for Retirement Savings.  This one is called the 45% rule.  For a general rule of thumb, this one may actually be pretty good.  

Watch Now:  Breaking Down Fidelity's 45% Rule


0:00 - Intro
0:41 - A generic guideline that makes sense
1:31 - The math behind replacing income
2:19 - Estimating the amount of income you will need from savings
3:11 - It is a good starting point
3:44 - Generic rules like this have limitations
6:32 - Outro

A guideline that makes sense...

There are many general rules of thumb people use to start thinking about various topics.  Some of them are better than others.  In general, we have found that the 45% rule crafted by fidelity is at least a good starting point. 

One of the key components of any retirement plan is knowing how much you will spend in retirement.  We often find this creates challenges for many people.  Many people simply will not trudge through the monotony of creating a budget.  

The other key component is understanding how much income you will need from your savings.  That is what the 45% rule attempts to illustrate.

Replacing income for an "average" couple

The average earnings for a couple in America is $87,864 per year.  How much of this income will they need to replace in retirement? And how much will need to come from their savings?

Income replacement - the math

Certain common deductions from your paycheck will not be a part of your retirement expenses. Most retirees don't pay Social Security or Medicare taxes.  You also won't contribute to your 401k.  And while you may have some expenses for health insurance, it may not be what you normally see deducted from your paycheck. 

In this example, this couple will need roughly 72% of their gross pay in retirement to replace their pre-retirement income.

Factoring Social Security Benefits

Most Americans will receive Social Security Retirement Benefits.  These benefits are "progressive."  The system is designed to replace a higher percentage of lower earners' income than higher earners.  

This example estimates the amount of income our average couple will receive from Social Security and what percentage of their income it will replace.

In this case, our average couple will need roughly 37% of their income to come from their savings.

A good starting point...

When we start the retirement planning conversations with clients, the spending part of the equation can be an obstacle to making meaningful progress in their plans.  This is an easy way to overcome the roadblock and start having meaningful conversations and crafting a realistic plan.  

Limitations of generic rules...

Like any general guideline, there are a number of limitations.  Here are just a few...

  • LIfe changes quickly - Your life is going to change between now and retirement.  The numbers you estimate today will be much different in a couple of years.
  • Retiring earlier or later will change the numbers - If you want to retire earlier your Social Security benefits will be less, and your savings will have to do more for you.  Retiring later can increase your Social Security which means you'll need less from your savings.
  • Higher earners may need more from their savings - Social Security replaces a smaller percentage of your income if you earn higher amounts.
  • The Government can (and will) alter the path - Whether it is the looming Social Security deadline or other factors, the government will have an impact in our lives at some point.

If you would like to have a more in-depth conversation about how to use this to help you plan for something better, let us know.  Just fill out the form below

Appearing in this video - 

Vince McManus

Vince is a financial advisor in Parkersburg, WV

Neal Watson, CFP

Neal is a Certified Financial Planner Professional in Marietta, Ohio