There are three common assumptions that financial advisers most frequently use to set clients’ retirement savings goals, according to analysis from Morningstar Investment Management. These include a 70% to 80% income replacement ratio, an income need that rises with inflation and a 30-year retirement time horizon.  

“When we looked at actual retiree spending patterns and life expectancy, however, we find that these assumptions don’t hold true for many people and, on average, can significantly overestimate how much people will actually need to fund their retirement,” says David Blanchett, head of retirement research for Morningstar Investment Management.

That’s in large part because expenses often disappear after retirement, such as Medicare taxes, Social Security taxes and retirement savings. By accounting for taxable and non-taxable expenses that are no longer paid after retirement, income ratios can often be safely revised downward from the 70% or 80% benchmark, Blanchett argues.

Another factor, derived from government data, is that retirees’ spending patterns typically grow at a rate lower than inflation through most of retirement. Spending acceleration, the data shows, doesn’t usually occur until a retiree’s later years—usually because of health care costs. While the difference between the actual spending growth rate and the inflation rate is relatively small, it has a material effect over time, Blanchett argues.

Additionally, regarding married couples, modeling actual spending patterns over a real life expectancy, rather than a fixed 30-year period, suggests many retirees could save approximately 20% less than the common assumptions would indicate. 

"While a replacement rate between 70% and 80% may be a reasonable starting place for many households, we find that the actual replacement rate can vary considerably," Blanchett says.

Other considerations include a retiree’s plans to relocate—or not—when hitting retirement.

As an example, Blanchett points to a hypothetical high-income couple living in a high-tax state like California and saving a significant amount for retirement each year. If that couple retires in Florida or Texas, where there is no income tax, Blanchett argues the income replacement rate could safely fall to 60%. By contrast, a low-income couple saving very little for retirement and retiring in California would need a replacement around 85%.

“It's important for investors to consider their level of pre-retirement household income, expenses that discontinue after retirement, and post-retirement taxation," Blanchett explains.

A complete copy of the research paper is available here.