Retirement means different things to different people, but when I refer to “retirement” I mean not needing (or wanting) to work for money anymore – to be able to afford to stop working and use built up investments & superannuation to fund your lifestyle.
When thinking about our golden years, how much is enough to retire comfortably on? The answer will be different for everyone because it depends on several variables:
The earlier someone “retires” and the longer they live the greater level of funds required. Unfortunately the majority of Australians face a very real risk of outliving their capital. Whilst the average “Life expectancy” is around 85, with medical advances many of us might live to 95 or 100. While I’m sure most of us would be happy to be around to 95 or 100 if our health is good, that’s a long time to fund our lifestyles. And there is certainly no guarantee that there will be the same level of Age Pension in the future. The full Age Pension is only $18,077 for singles and $27,250 for couples anyway. This may cover the basics – but I doubt anyone just wants to live a “basic” lifestyle in retirement.
2) Cost of living to fund the level of lifestyle you want to have over time
Several studies have looked at what level of expenses would give a single person or couple a comfortable lifestyle in “retirement”. Most studies indicate that the average retired couple need to spend around $55k per year to fund a comfortable lifestyle; but from my many meetings with clients over the years, I find most want the ability to spend around $70k per year. This might be $55k to fund the comfortable day to day living, and $15k for holidays and travel throughout the year. (Having said this, I have many retired clients who have a great lifestyle and are happy spending $40k; it really comes back to what you want and what is realistically affordable and achievable).
3) The rise in cost of living over time
In our retirement planning analysis, we use 3% as an assumed rise in the cost of living over time (which is roughly the CPI average). If you want to be even safer, use 4% in your calculations.
4) Investment returns achieved over time
This is another major factor. The higher the returns achieved over time the less capital amount required to fund “retirement” cost of living. However of course the reverse is also true – the lower the average investment returns, the greater capital is required. The higher the investment return required, the higher the risk of loss as well……the old risk/return trade off. One important consideration is the level of returns required to achieve your goals. As an example: If you can comfortably achieve your future lifestyle goals of covering the cost of living you want in an ongoing and sustainable manner from retirement through to life expectancy by earning on average say 7% from investments… why try to earn 12%? Why dramatically increase the risk of losing capital and not achieving your goals if the risk is not necessary? On the flip side of this there will be many people who need to earn a higher return over time to achieve their retirement funding goals. If you’re in this situation you need to be aware of and comfortable with any risks taken and of course do what can be done to manage and reduce risk over time. This highlights the importance of planning ahead and building up sufficient “retirement” savings so only low to moderate risks are necessary in order to comfortably cover your future lifestyle.
Here are a few practical examples around “how much is enough?” which you can apply to your own situation and, purely as a guide, see approximately what level of investment assets will be required to fund the lifestyle you want in “retirement”.
As mentioned, the level of investment assets required depends upon a few variables including retirement spending goal per year, rate of return achieved, and time frame (life expectancy). There are plenty of other variables of course such as tax paid/refunded (as with franking credits) and inflation.
For the sake of the examples below, inflation is assumed to be 3%, no tax is payable (assuming at least part of the investment assets are in the superannuation environment and tax free in Pension phase) and franking credits have been ignored. Additionally the amount of investment assets required below assumes that you fund your “retirement” purely on your own with no Age Pension being paid. Any Age Pension received will obviously mean less investment assets are required. Whilst there may not be an Age Pension down the track, it is likely to be around for a while yet – so do not despair if you are approaching retirement and don’t have anywhere near the level of required investment assets detailed below.
Also below I have kept the “retirement” age constant at 65 and looked at funding the level of required expenditure through to life expectancy of 86. Of course you may need/want more in say the first 10 years of retirement (to travel a bit more for instance) than the second 10 years of retirement. But for the sake of simplicity I have kept the spending goal constant throughout (albeit rising by 3% assumed inflation).