Saving for Retirement
Regardless of the age you are at there are several things you and your adviser can do before you transition into retirement.
Two main questions pre-retirees have are:
- How much will they need to retire on? The same question put in another way is whether or not they have enough funds to retire or not.
- Will they be able to access any social security benefits? It is not a question that all pre-retirees ask but for the general populace it is on their minds.
As advisers we can help the pre-retiree to answer these questions. The first one involves going through a budget and goal exercise. The second question relates to the client’s assets they own and/or the income they will be able to generate from their investments. In this section we will look at how much money a retiree will need and one of the most common strategies that pre-retirees can implement to improve their situation as they get closer to retirement, knowns as Transition to Retirement (TTR).
Do I have enough for retirement?
One of the biggest questions on a pre-retirees mind is ‘do they have enough money to retire?’
There is no quick way to answer this question as it can involve a lot of variables. Every person is different and his or her needs will be different in retirement. For instance, will all your debt be paid off? Will there be siblings requiring adult care? How often will you want to go on holidays or replace the car? Given everyone is different, all we can do is provide some guidance as to some ways to determine the amount needed for retirement. You may wish to present the different models to the client and ask them to choose which one they feel will be more appropriate and then go from there.
Option 1: Multiplier of Income method
One method that has been used by advisers in the past is to multiply out the client’s pre-retirement earnings and use this as the bases for the amount of money they will need to have for retirement. The assumption is based on how long the client will live for. If they client believes they will live for 20 years after retirement then multiply the income they are earning at pre-retirement by 20. This will in effect provide 20 years of income to the client if they were to drawn down the lump sump amount as long as the invested amount is keeping up with CPI.
This method is very simply in nature and for a lot of people it might be hard to accumulate the amount this formula would derive.
Jane is 60 years of age. She is currently earning $100,000 of income and is living quite comfortably. She goes to a financial adviser to ask how much she will need to have to retire on. The adviser uses the quick Multiplier of Income method and calculates that Jane will require $2,500,000 million dollars of savings if she were to retire at age 65 as Jane believes she will live for 25 years. For Jane this is depressing news as she currently only has $500,000 saved up and there is no way she can save an additional $2million to meet this requirement.
The downside to this method is that it does not take into account the potential in tax savings, reduction in expenditure, future goals and growth and earnings on the monies that are invested.
Option 2: Multiplier of Expenses method
Instead of multiplying the pre-retirees income we can multiply the pre-retirees pre-tax expenses. The pre-retirees would work out a detailed budget that they would live on in retirement. This amount would then be multiplied by a number that is based on life expectancy or when they client is going to retire.
For instance, an adviser might decide that if a person was going to retire at age 55 they would use a multiplier of 25, age 60 a multiplier of 20, and at age 65 a multiplier of 15.
Jane is 60 years of age. She is asked to fill in a detailed budget that she believes she can live on in retirement. As she is going to retire at age 65 her total budget is multiplied by 15 to gain the amount she would need in retirement. If her budget worked out to be $55,000 per year then the total amount she would require would be $825,000. This is considerably different to the amount required under Option 1 above. Jane would only need to save up less then $300,000 with in 5 years.
Whilst this method might be a lot more accurate than the previous method it still does not take into account future goals, and growth on the income and expenses that are being invested.
Option 3: The 70% rule
With the 70% rule you simply multiple the pre-retirees current income by 70% and assume this will be the income the pre-retiree will have in retirement. The amount is then multiplied out based on life expectancy or by a pre-determined figure based on when the pre-retiree wants to retire (similar to Option 2).
This method has been adopted the most as it is a quick way to calculate a pre-retirees income in retirement.
Option 4: ASFA Retirement Standard
When retirees don’t have any idea as to the amount of money they are going to spend in retirement, you can always point them to the ASFA Retirement Standard, that is published by the Association of Superannuation Funds of Australia Limited.
The AFSA have published what they consider to be the amount you will require each year for a Single person and a Couple on a Modest and Comfortable Lifestyle (http://www.superannuation.asn.au/resources/retirement-standard/).
Current tables published by the ASFA show that Couples require about $59,160 to live a Comfortable lifestyle.
All figures in today’s dollars using 2.75% AWE as a deflator and an assumed investment earning rate of 7 per cent. They are based on the current means test in place for the Age Pension as of 1 January 2017.
Advisers can direct their clients to the ASFA website and ask them what type of lifestyle they would prefer. If they choose the ‘Comfortable’ lifestyle then the adviser has a figure they can work with.
According to the ASFA Retirement Standard a couple will need to save about $640,000 and Singles $545,000 to have a Comfortable lifestyle in retirement. The Standard is updated four times a year to take into consideration the changes that occur in pricing of items, lifestyle and spending habits. The Standard also takes into consideration holidays and money to spend on clothes and other items.
The table below gives an example of what is considered to be included in a Comfortable and Modest lifestyle: (Source: http://www.superguru.com.au/retiring/how-much-super-will-I-need/)
In our previous examples Jane would have needed to save more to meet her retirement objectives. Based on the ASFA Retirement Standard, Jane would only require $545,000 as a Single person. Imagine Jane’s happiness to discover she has nearly already saved up enough in her super and could potential retire earlier than she had anticipated. Keep in mind that this scenario is taking into consideration the Age Pension whereas the other options were not.
There are many ways to determine what income a pre-retiree will require in retirement. It is up to each adviser to choose which method or a combination of methods they will use to determine the income of the retiree.
AFSA Retirement Standard (http://www.superannuation.asn.au/resources/retirement-standard/). Challenger
Dollar and Sense in Retirement (http://insights.mlc.com.au/retirement/2015/04/dollars_and_sensein). MLC
Budget Calculator (http://www3.colonialfirststate.com.au/resources/tools.html?gclid=CP7ouv6z68YCFVckvQodc9cIdA&c). Colonial First State
Budget Planner (https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/budget-planner). MoneySmart
AFSA Retirement Budget Calculator (http://www.superannuation.asn.au/ExternalFiles/rs/ASFA_RetirementStandard.html)