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Replacement Rate

The replacement rate is the percentage of post-retirement income with respect to pre-retirement income. For example, if your annual salary was $40,000 before retirement and you have $30,000 in annual retirement income, your replacement rate is 75% ($30,000/$40,000). Often, the annual income you need in retirement is less than what you need while employed, because:

In retirement, one is generally not setting aside any or as much income for saving.
Work-related expenditures decline.
One is not paying as much in income taxes.

But how does one calculate an adequate replacement rate that will likely provide a retiree with enough income to meet his or her needs? Many studies attempt to do this, but they are only rough estimates because circumstances vary from person to person. We have used the consulting firm Aon’s replacement rates2 in some of our studies and generally agree with their calculations.

The following two tables show replacement rates for various income levels. These tables break down replacement rates into the components of Social Security (SS) income and other income (this includes employer-sponsored retirement plans and personal savings). Table 1 is based on a household in which one spouse is employed and receives family SS benefits. Table 2 is based on a single person household receiving individual SS benefits.

Example George is single and has been living on an annual income of $50,000 before retirement. He will need to replace approximately 79% of his income ($39,500) in retirement. Social Security will replace 36.7% of his income; he will need to replace 42.3% of his income from other sources.

Aon Consulting. Replacement ratio study: a measurement tool for retirement planning. 2008. www.aon.com/about-aon/intellectual-capital/attachments/human-capital-consulting/RRStudy070308.pdf

Table 1: Retirement Rate Baseline Model - 65 year old retiree and spouse

Annual Income	Social Security	Other (pension, 401k, savings)	Total Required (Aon Calculation)
$20,000	69.0%	20.0%	89.0%
$30,000	58.7%	27.3%	86.0%
$40,000	53.6%	28.4%	82.0%
$50,000	50.5%	28.5%	79.0%
$60,000	46.3%	29.7%	76.0%
$70,000	52.3%	33.7%	76.0%
$80,000	39.2%	36.8%	76.0%
$90,000	36.8%	40.2%	77.0%

Table 2: Retirement Rate Baseline Model - 65 year old retiree single

Annual Income	Social Security	Other (pension, 401k, savings)	Total Required (Aon Calculation)
$20,000	50.2%	38.8%	89.0%
$30,000	42.7%	43.3%	86.0%
$40,000	39.0%	43.0%	82.0%
$50,000	36.7%	42.3%	79.0%
$60,000	33.7%	42.3%	76.0%
$70,000	30.7%	45.3%	76.0%
$80,000	28.5%	47.5%	76.0%
$90,000	26.8%	50.2%	77.0%