Your Replacement Ratio – An Important Retirement Consideration

We recently came across an interesting article on retirement income replacement ratios. What is a retirement replacement ratio?

Here’s a good definition:

A Replacement Ratio is a person’s gross income after retirement, divided by his or her gross income before retirement. For example, assume someone earns $60,000 per year before retirement. Further, assume he or she retires and receives $45,000 of Social Security and other retirement income. This person’s replacement ratio is 75 percent ($45,000/$60,000).

Typically, a person needs less gross income after retiring, primarily due to several factors:

Income taxes go down after retirement. This is because extra deductions are available for those over age 65, and taxable income usually decreases at retirement.

Social Security taxes (FICA deductions from wages) end completely at retirement.

Social Security benefits are partially or fully taxfree. This reduces taxable income and, therefore, the amount of income needed to pay taxes.

Other forms of retirement income, like pensions, are often are exempt from taxation by states

Saving for retirement is no longer needed.

For all the reasons listed above, conventional wisdom has it that most people will need about a 75% replacement ratio to maintain their standard of living in retirement. Discussion typically focuses on finding ways to maximize sources of replacement ratio income: social security, pensions and retirement savings (401k, IRA, 403b, 457, etc.).

But with company pensions non-existant for many workers and 401k plans imploding, the reality is that many people nearing retirement will not achieve a 75% replacement ratio. In essence, many people will find they cannot retire as planned or, they will need to retire to a different lifestyle and/or standard of living.

But this does not have to mean retiring in poverty or making huge lifestyle sacrifices. In many cases, moving to a lower cost area can help bring retirement finances back into balance. For example, in the Midwest, retirees living in large cities like Chicago or Milwaukee paying housing, taxes and other living expenses that are far greater in nearby smaller cities.

If you are nearing retirement and wondering how you will ever make ends meet, we encourage you to browse this website to see if Muskegon, Michigan might be the right place for you to call home in your retirement years.

Filed under: Retirement Planning Thoughts

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Important Michigan Pension Tax Law Changes to Know About

A new law governing how retirement income will be taxed starting in 2012 sets up a three-tier system, depending on a retiree's age. All three tiers avoid taxing Social Security income and military pensions. For couples, the age of the older spouse applies. Here's how the system works:

• Residents born before 1946 will continue to get the same tax breaks they have now. Public pensions will not be taxed. Income from private pensions, 401(k)s and IRAs will not be taxed on amounts up to $45,120 for single filers and $90,240 for joint filers. This will affect about 480,000 tax returns.

• Residents born between Jan. 1, 1946, and Dec. 31, 1952, will have all retirement income liable to tax, whether it's from a public or private pension, 401(k) or IRA. Exemptions can be claimed for up to $20,000 for a single filer and up to $45,000 for joint filers. Above those levels, retirement income will be taxed at the state income tax rate of 4.35 percent. When these residents turn 67, the $20,000/$40,000 exemption applies to all income, not just retirement income. If household resources exceed $75,000 for a single return or $150,000 for a joint return, the $20,000/$40,000 exemption is eliminated. The exemption also is eliminated if a taxpayer claims a deduction for a military or railroad pension. This will affect about 230,000 returns.

• Residents born after 1952 will see all retirement income taxed as regular income until they turn 67, at which point they'll qualify for a senior income exemption of $20,000 for single filers and $40,000 for joint filers on all income. If household resources exceed $75,000 for a single return or $150,000 for a joint return, the $20,000/$40,000 exemption is eliminated. A taxpayer can forgo the $20,000/$40,000 exemption and instead deduct 100 percent of Social Security income. A taxpayer claiming the $20,000/$40,000 exemption can't claim the deduction for Social Security or the standard personal exemption. This will affect about 150,000 returns.

Sources: Senate Fiscal Agency, Treasury Department

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Your Replacement Ratio – An Important Retirement Consideration

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