Replacement Ratio

You’ve got a 401(k)...or maybe a Roth IRA...or maybe both. If you don’t, get on it.

As retirement looms nearer and nearer, you’re going to start thinking less about maxing out your employer’s match and your IRA contributions...and more about how much money you’ll have each year. How much retirement income you’ll have depends on multiple factors, including how long you’ll be alive. But if you’re getting a pension, you can expect a regular percentage of money coming at you every month. Pension programs are programs where you pay into an employer-controlled investment fund while you work, and then you get regular payouts from it once you retire. They’re more common in the public sector than private.

The replacement ratio compares how much you’re getting in pension payouts compared to your income before you retired. For instance, if you were making a solid $100k per year, and you’re going to get pension payments that amount to $80,000 a year, then your replacement rate is 80%.

Replacement ratios can also be used more widely. For instance, if you’re getting money from multiple retirement accounts and Social Security, you can total that income and divide it by your old, pre-retirement income to get your replacement ratio. When you’re retirement planning, you’ll want to determine a minimum replacement ratio you’d be down with, and then figure out how to make that happen.