The retirement savings safety measure

Are your savings on track for a comfortable retirement? Here’s how to check.

Summary: ASFA calculates that a home owning couple will need $58,444 per year for a comfortable retirement, which means the couple needs $1,299,000 of investment assets if they withdraw at a rate of 4.5 per cent. In order to be on track for a comfortable retirement from age 60, the couple needs assets of 4.5 times their retirement income at age 40, and 11.25 times their retirement income at age 50.

Key take-out: Savers who are behind at any stage can increase contributions, while savers approaching retirement can use the transition to retirement strategy to provide a final boost.

Key beneficiaries: General investors Category: Superannuation, retirement.


 

The Senate has now passed legislation that makes the assets test for the age pension harsher – meaning that a home-owning couple with retirement assets of $823,000 no longer receives a part age pension. This is a significant reduction from the current level of $1,156,500 – meaning that many people currently receiving some part age pension will no longer do so once these changes come into effect in January 2017.

For those people planning for retirement, these changes do flag a key issue – for anyone planning on a ‘comfortable’ retirement, the age pension will no longer play any part in supporting them – they will need to accumulate assets beyond a level where they will qualify for any part age pension support.

So, with these changes in mind – can we benchmark how much we need to have accumulated at different ages to be content that we are on track to having a comfortable retirement? The first question we have to look at, then, is how much do we need for a comfortable retirement?

How much is needed for a comfortable retirement?

In defining what a comfortable retirement is, the Association of Superannuation Funds of Australia (ASFA) has put together a very interesting calculation of what is required. They find that, as of the March quarter, a home owning couple aged 65 will require $58,444 per year and a home owning single person will require $42,569 per year.

The following table sets out the March ASFA calculations of what is required for a ‘modest’ and ‘comfortable’ income for someone around 65 years of age.

Modest

Comfortable

Single home owning retiree

$23,438 per year

$42,569 per year

Retired home owning couple

$33,799 per year

$58,444 per year

(Source: ASFA)

Interestingly, the full age pension will provide almost all the financial resources needed to provide ASFA’s calculation of a ‘modest’ retirement. For those retirees and prospective retirees who aspire for a ‘comfortable’ retirement – they will have to do it using their own assets.

The starting point: At retirement what level of assets do we need to produce this income?

This is an important question in retirement – effectively looking at the question of how fast we can draw on our assets in retirement. If someone has accumulated $1,000,000 by retirement, then can they reasonably expect this to produce $30,000 of drawings (income) per year, or $50,000 or $70,000?

In a previous article I looked at a range of evidence that suggested a sustainable withdrawal rate from an investment portfolio of 4.5 per cent per annum (details about this assumption are here: Spending in retirement: How much is enough?, April 22, 2013). An important part of those assumptions revolved around a person having exposure to growth assets (shares and property), and with the cash rate at historical lows that is more important than ever. Importantly, the modelling was based on the withdrawals from the portfolio increasing each year by inflation, an important real life assumption.

This gives us the starting point for building our wealth benchmarks. $1,299,000 of investment assets (not including the family home) will allow a home owning couple to withdraw from their portfolio at an initial rate of 4.5 per cent, which equates to $58,444 per year to fund their retirement. They should be able to increase the amount taken from their portfolio in line with inflation each year (and as dividends from their share investments tend to increase, and rental income from property investments). For the home owning single person, $946,000 is the level of wealth that is required to produce the $42,569 that provides a ‘comfortable’ retirement for a single person.

This level of assets, for both the home owning couple and home owning single person, will exclude them from any age pension assistance.

One quick comment – the AFSA calculations of retirement income acknowledge that as a person ages in retirement, they tend to spend a little less. For example, they calculate that a home owning couple at age 65 needs $58,444 for a comfortable retirement, whereas by age 85 this has fallen to $53,424. This provides a ‘margin of safety’ in our assumptions – if the rate of drawings falls slightly over time, there is a greater chance that the investment assets will be able to meet those drawings.

The goal posts: What is needed for people at different ages

The following calculation provides some idea of what a person or couple, at different ages, might need to have to be on track to retire at age 60 and enjoy a comfortable retirement.

It starts from age 30 – and assumes that little wealth has been accumulated up until this point, probably just some superannuation contributions from working. It also assumes that the assets receive investment earnings, after tax and inflation, of 4.5 per cent per year. The next input is the total amount of contributions that happen over a decade. For example, I have assumed that between the age 30 and 40 a single home owner is prepared to contribute $10,000 a year to their investment portfolio (for most people the majority of this will be their 9.5 per cent compulsory superannuation contributions), and a home owning couple $15,000 per year. The amount of the contributions increases each decade based on the tendency to earn more as our careers progress, and have fewer expenses as mortgages are paid off and as children become financially independent.

The following table sets out the full calculations:

Investment wealth (inside and outside of superannuation) needed to be accumulated to be on track for a ‘comfortable’ retirement from age 60

Single Homeowner ($)

Couple Homeowner ($)

AGE 30

40,000

60,000

Decade Contributions

100,000

150,000

Investment Earnings

47,333

71,000

AGE 40

187,333

281,000

Decade Contributions

150,000

175,000

Investment Earnings

142,359

201,081

AGE 50

479,693

657,081

Decade Contributions

165,000

247,500

Investment Earnings

309,940

429,907

AGE 60

954,633

1,334,488

Moving these benchmarks over time

The problem with figures like these is that inflation will quickly reduce the purchase power of these savings. In 10 years time, people meeting these targets will not have enough money to be thinking about a ‘comfortable’ retirement.

To keep them relevant regardless as a benchmark over time, I have recalculated them as a multiple of the target retirement income. For example, if you have 1 times your target retirement income at age 30, and 4.5 times your target income at age 40 you are well on track for retirement. To demonstrate this, let’s consider a time (probably well into the future) when ASFA calculates that $100,000 is needed for a comfortable retirement. The benchmarks mean that at age 30 you will need $100,000 and at age 40 you will need $450,000.

Because the investment return we have used is after inflation, the amounts already accumulated should keep up with inflation; it is just future contributions that might need to be adjusted.

Financial benchmarks at different ages (as a multiple of targeted retirement income)

Age

Multiple

Age 30

1 times retirement income

Age 40

4.5 times retirement income

Age 50

11.25 times retirement income

Age 60

22.5 times retirement income

While we have not completed any calculations for non-home owning couples, these can now be calculated using these benchmarks and target retirement incomes.

Strategies if you are behind

Part of aiming for retirement at age 60 is that it builds a ‘margin of safety’ into your calculations, in that you are likely to be able to continue to work for a little longer if you have not accumulated enough to retire at that time. Hand in hand with this is one of the most powerful tax saving strategies, the transition to retirement income stream, where you salary sacrifice as much of your superannuation as you can while drawing a tax free pension from your superannuation assets. This becomes particularly effective at age 60 – perhaps providing a final ‘boost’ toward retirement.

If you are behind where you need to be at any stage, perhaps because of poor market returns over a period of time, you can increase your contributions. 

Of course, if you are really keen to retire but have not accumulated quite enough, you can adjust the expectations of your annual drawings down a little.

Conclusion

The age pension changes mean that if you want a comfortable retirement, you are on your own. By setting goals for where you need to be at different ages, you can get a sense of whether you are on track for a comfortable retirement.

Of course, you can adjust any of the inputs into this model as you see fit. For example, if you particularly like cash as an investment class and want to hold most of your assets there, then clearly an earnings rate of 4.5 per cent after inflation is not achievable. In that case reducing the expectations of investment earnings, while increasing contributions, will make the model make more sense for your situation.


Scott Francis is a personal finance commentator, and previously worked as an independent financial adviser. The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.

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