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"Your Money Ratios"
Old 06-30-2010, 12:29 AM   #1
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"Your Money Ratios"

Has anyone else read this? The book provides financial planning formulas into which you can plug your specific information to get the amount you should have accumulated by various certain ages, in order to retire at 65 on 80% of your salary, and the other numbers like savings amounts, debt ratios, etc, that will put you in a position to hit that target.

The first chapter is your capital to income ratio, and the basic assumptions are: 5% withdrawal rate on your savings generates 60% of your final salary, and Social Security provides the other 20%, for a total of 80%. In order for a 5% WR to provide that amount of income, you need to have accumulated 12x your income by age 65. So far, so good.

Where I run into a question is the appendix that tells how to revise the calculation if you have a pension coming. Instead of using your whole salary as a multiplier, the author says to apply the ratio to that portion of your salary that won't be replaced by the pension.
"Assume we have a 45-year-old worker who earns $60,000 and will have a pension worth 50% of his pay at retirement. this means the worker needs to figure out how to cover the other $30,000 (50% of his salary) with his own retirement savings. Therefore, the worker should benchmark his Savings Ratio and Capital to Income Ratio using the $30,000 of salary he must cover himself....At age 45, his Capital to income Ratio should be 3.7. The Capital to Income Ratio is applied to the $30,000 of his pay that is not covered by his pension. Thus, at age 45, he should have 3.7 times $30,000 saved, or $110,000."
Hasn't the author left out Social Security in making the adjustment? This person has a pension that covers 50%, and (based on the author's assumption) Social Security that covers 20%. Doesn't this mean 70% of his salary will be replaced in retirement, and he only needs to replace the other 30%, making his correct multiplier $18,000), and the required savings amount at age 45 3.7 x $18K=$66,600?

Leaving aside for now the question of whether it's really necessary to have 80% of salary to retire, whether a 5% WR is safe, and how much of the promised Social Security benefits will actually be paid, it still seems to me that one of us—either I or Charles Farrell, J.D., LL.M—is off the mark by a considerable amount.

Which of us is it?

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Old 06-30-2010, 05:15 AM   #2
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I think you are correct and his math is not consistent. If SS is 20% of $60, or $12k, and pension is 50% of $60k, then their savings need to generate $18k/year -- which requires $66.6k at 3.7 ratio.

Regardless, no one is going to have a 50% pension in the future. And I think those ratios are far too low -- we know that a 4% SWR to replace 80% of one's income requires a 20x ratio -- to have a target of only 7.1 at age 55 is too low.

Here's some more discussion on topic:

Free Money Finance: The Capital to Income Ratio

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Old 06-30-2010, 07:42 AM   #3
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Check out the ballpark calculator at

Also here's a fun little chart that is as good as just about anything for assessing where you stand.
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Old 06-30-2010, 07:57 AM   #4
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As quoted in the OP:

"Assume we have a 45-year-old worker who earns $60,000 and will have a pension worth 50% of his pay at retirement. this means the worker needs to figure out how to cover the other $30,000 (50% of his salary) with his own retirement savings.
This is a fallacy that needs to be called out. This assumes that he currently needs all of the $60,000 he earns and that he will continue to do so in retirement.

If it turns out he's also saving $12,000 a year for retirement, that's an expense that goes away *in* retirement, so now he needs $48,000 in retirement. Maybe wardrobe, transportation and dining out expenses go down by $4,000 a year. Now his need is down to $44,000. Maybe his health care costs rise by $3,000 so we're back to $47,000.

But if he has an income of $47K instead of $60K, his income taxes probably drop another $3K. So now we're down to $44,000 with the same lifestyle as today, and he really needs to generate $14,000 a year to match current lifestyle -- a far cry from $30,000.

And this doesn't even begin to factor in Social Security. If he doesn't even retire until full retirement age, SS likely covers that entire $14,000 with a little room to spare, and his personal retirement savings *need* drops to zero -- SS and a pension would provide his entire income need at current lifestyle levels. (Not that it's wise, but that's what the numbers would tell you.)

Having said that all, it's certainly prudent to err on the side of saving a little more than you'll need. But in completely neglecting Social Security and in assuming that someone's current income is what they need in retirement, the off-the-cuff calculation is pretty bad.

[Edit to add: It also doesn't say whether the pension has a COLA kicker, which can make a significant difference.]
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Old 06-30-2010, 07:58 AM   #5
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Here is the problem I have with any of those "percent of income replacement" calculations. They don't take into account one's own expenses.

If I had still been working full-time, I'd be earning about $100k per year. My current expenses in ER, including the costly health insurance, are about $22k, or 22% of my previous full-time gross pay. (I worked part-time for 7 years so I saw my pay drop to 30% of its full-time level.) One's ER expenses are not related to one's current income, as my expenses would be $22k even if my annual gross pay (part-time or full-time) were $30k, $50k, or $100k.

IOW, figure out your retirement expenses from the bottom up, not from the top (i.e. income) down.
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Old 06-30-2010, 08:12 AM   #6
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What you post is indeed true. Expenses drive your nest-egg size need. Clearly someone making $1M/year won't really need 80% of income. And some one making $44k just may need it all and more.

Nonetheless having some sort of benchmark indicators as you progress makes a lot of sense. The benchmarks can be adjusted as needed to suit your situation.
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Old 06-30-2010, 05:21 PM   #7
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I can never figure out the proper adjustments to these sorts of tables, when one spouse is retired on a pension, one spouse is earning a salary and paying into a pension, and neither is entitled to SS.

FireCalc is the best analytic tool I have found so far, for our situation.


Originally Posted by MasterBlaster View Post
Check out the ballpark calculator at

Also here's a fun little chart that is as good as just about anything for assessing where you stand.

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