How Much Do I Need To Retire?
How Much Money Do You Need To Save For Retirement?
While it seems like a very simple question, the response is complicated, because there are so many variables that can shape the answer— sometimes dramatically. Additionally, there are different retirement planning strategies for all ages.
When you are in your 20s, 30s and 40s, you need to build your retirement savings. Those in their 50s and 60s must find the resources to continue to build savings and accumulate wealth as they prepare for retirement. These folks are also strategically thinking about things like Social Security and long-term care planning.
It’s important to note that no matter how old you are it’s never too late to improve your financial circumstances. You should seek a retirement planning professional to assist you in your retirement plans no matter what your age.
Theoretically, how much money you need in retirement depends on how long you are going to live. In order to know how much you need to retire, we first should look at how much we need to survive on retirement. The Association of Superannuation Funds of Australia (ASFA) retirement standard found a couple looking to have a comfortable retirement need $58,128 a year while those seeking a modest retirement need to spend $33,664 per year.
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How Much Is Enough?
How much extra money you contribute to your super depends on what you’ll need to live off once you retire. The amount of super you need depends on:
- How long you live
- What type of lifestyle you want
- Future medical costs
The table below will give you a rough idea of how much money you need to support a modest or comfortable retirement. The table also outlines different categories and the type of lifestyle you’ll be able to live. It applies for people retiring at age 65 who will live to an average life expectancy of about 85.
The Two-Thirds Rule
Another way to estimate how much money you will need in retirement is to assume you need 67 percent (two-thirds) of your income before you retire in order to maintain the same standard of living in retirement. This estimate is only suitable for high-income earners.
ASFA estimates the lump sum needed to support a comfortable lifestyle for a couple is $510,000 (or $430,000 for a single person) assuming they are also receiving a partial Age Pension.
ASFA also estimates that because a modest lifestyle is mostly met by the Age Pension the lump sum required to support it for a couple is $50,000 ($35,000 for a single person).
It’s never too early to start thinking about how to maximise your income in retirement. By acting earlier, you have a better chance at achieving and funding the lifestyle you want.
A common rule of thumb is that if you want to retire at 60, you will need about 15 times the amount you have calculated for your annual after-tax retirement expenses. So if you estimate $60,000 per year then you will need $900,000.
If you can wait until 65, you may only need 13 times expenses, which will be $780,000. Remember, if you plan to leave a legacy to your children or have a holiday home, then you need to add the cost to this estimate.
If you’re planning to retire soon, a good back-of-the-napkin estimate is to have a retirement portfolio that’s roughly 25 times the value of your annual retirement income. It goes like this: Consider how much money you want in annual income. Then subtract any government benefits and any other guaranteed income, such as a pension, and then multiply by 25.
For example, if you need $120,000 per year in retirement income and you’ll receive $30,000 from the pension, you’ll need roughly $2.25 million ($90,000 x 25) in savings.
The 4 Percent Rule
The 4 percent rule is likely the most common, cookie-cutter technique in retirement-income projections. This approach applies a 4 percent withdrawal rate to your total retirement portfolio in year one and then increases that amount by the rate of inflation each year thereafter.
So if you have a $2,000,000 portfolio and retired today, you would withdraw $80,000 in income for your first year of retirement. Moving forward, regardless of what happens in the markets, you’d withdraw your base amount plus the corresponding rate of inflation.
For ease of illustration, if we assume a fixed 3 percent inflation rate, you’d withdraw $82,400 in year two, then $84,870 in year three, etc. The research behind the 4 percent rule suggests that during the past century, investors would not have exhausted their assets during any 30-year period. The criticism of the 4 percent rule is that the withdrawal rate isn’t flexible, and it may create a large end-of-life surplus.
The Market-Based Approach
Another popular approach used by some financial advisors is to base the retirement withdrawal rate on both the level of stock market risk in the total portfolio and the overall valuation of the markets.
This one is a bit more complicated, but in practice, it dictates a higher withdrawal rate—typically, the rate for moderate-risk retirees starts at around 4.4 percent and can go as high as 5.7 percent. For a more conservative investor, the rate starts at about 3.9 percent and goes as high as 5 percent.
The Custom Approach
The custom approach places significant emphasis on your personal objectives and goals. It should also take into consideration your investment risk tolerance, current market valuations and the timing of your income and expenses.
In practice, retirement planning is different for everyone. For that reason, the custom approach can be far better than the alternatives. For retirees in need of flexibility, the above methods could pose problems.
Unfortunately, the “Australian Dream” of owning your own home is getting in the way of funding your retirement. Leaving a “gaping hole” in many people’s savings. The simple issue is that people are living longer. For a lot of people, there’s a big hedge in their back pocket and that’s the family home. Most people say that will finance half of all of their retirement living.
Many would rather not sell their family home because they would rather live in it, but some downsize to supplement their lifestyle and this is all due to insufficient retirement savings.
Australians can retire on the age pension at 65 but this will increase to 67 in three years. The Federal Government this year announced the minimum retirement age would increase to 70 by 2035.
Managing your finances and setting yourself up for retirement requires expert help and the sooner you speak to a professional about our retirement the faster you will be on track to working on the right plan for your lifestyle and situation.
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