Updated: April 2018
Imagine a lifestyle where you don’t have to clock into work every day, can do whatever you want with your time, and still receive a paycheck. When phrased like this, retirement planning starts to look much more attractive than how the vast majority of Australians view it.
Retirement planning is never the most exciting part of financial planning, but it is easily one of the most important.
It’s easy to put off thinking about retirement since turning into that retirement age seems like a distant dream, but as each year passes by it starts to become more and more of a looming reality.
Thinking about retirement, even for a few seconds as you read this, can conjure up feelings of apprehension and anxiety. If that’s the case for you, you’re not alone.
It doesn’t have to be this way. This step by step guide is designed to take care of the retirement stress and thinking for you.
If you’d like to speak with one of our retirement planning specialists, book your free consultation today.
By the end of finishing this guide you will be familiar with how to:
- Understand what your retirement needs are
- Learn a variety of strategies to prepare for retirement
- Calculate your superannuation contributions and returns
- Calculate your retirement income
- Sit down with a financial advisor and put the learning into action
Read on to take the first step towards checking off retirement planning from that ever-growing financial to-do list.
Step 1: Know Thy Financial Self
Understanding What Your Retirement Needs Are
Knowing where you stand financially and what sorts of goals you have set for your life will make planning for retirement much easier. Your plans for retirement should be just a subsection of your overall financial plan. We highly recommend you build both out together.
For the scope of the section in this guide, we will focus on asking the right questions.
Question 1: What does it cost you to live a comfortable life?
This is one of the pillars of your retirement plan. In order to answer this, try as best to gauge how much money it would take you to live a comfortable lifestyle.
Question 2: How can you control your costs?
Casting a big picture view at your financial blueprint, knowing how you can change your costs to live a better life in the future is important.
For example: instead of renting your home for $1,500 a month, you could plan to purchase a property so you won’t have to pay rent once you retire.
Question 3. What is your risk tolerance?
This question is the cornerstone of all investing. Most high-yield investments usually have a high amount of risk involved, whereas the lower investments are more secure.
Some people are willing to deal with potentially losing a chunk of their investment in hopes of a big payout, whereas other people are more comfortable with an essentially guaranteed lower return every year. Retirement planning usually falls into the latter category.
Question 4. What is your cash liquidity preference?
Do you need the ability to have easy access to cash, or are you indifferent to having your money tied up to an investment?
Certain stocks, for example, are some of the most liquid types of investments because they can be sold on the market, whereas purchasing a property would require finding a buyer or taking out a loan with your property as collateral to have access to your money.
Question 5. What type of retirement lifestyle do you want?
This is a question that requires you to envision what sort of life you want to be living once you are no longer working. Some people envision taking annual trips across the world to Rome, Paris, and New York, and others are more content with just enjoying the great outdoors of Australia.
Retirement planning isn’t only about survival, it’s about freedom. Things such as the ability to take trips and dine out later in life are contingent upon the planning you do today.
Now that we’re thinking about our post-retirement goals, let’s start to quantify them. Let’s assume it costs $2,000/month to rent your home, $1,200/month for food, and you spend about $1,000/month on miscellaneous expenses, and you take an annual $10,000 vacation every year. This is a total of $60,400 per year to live your comfortable life.
Factor in that people will only be able to receive the government Age Pension at 65 and 6 months (as of July 2017), and the Age Pension age will continue to go up by 6 months every 2 years until July 2012.
The rest of the guide will continue to use the above example, but feel free to come up with your own based on your current lifestyle. We have also included multiple calculators for you to follow along as well.
Step 2: Plan a Superannuation Strategy
A Variety Of Strategies To Prepare For Retirement
You’ve probably heard the term “superannuation” or its common abbreviation “super” and have an understanding that it has something to do with retirement planning.
Beyond that, however, the average Australian doesn’t understand much about superannuation. As critical a component to retirement planning superannuation is, it’s surprising how it’s treated as an afterthought.
There is no need to fret or delay any longer. This guide will help you knock superannuation planning off your to-do list, or at the very least put you in a position to knowledgeably plan your superannuation in the future.
Although there are certain stipulations for effective superannuation planning, the concept is pretty simple. Basically, the goal of superannuation is to pay less tax now to help you live a more comfortable life after retirement.
The following are a few of the most common questions we get from our clients’ superannuation.
1. Isn’t my employer contribution enough?
No. Your employer is required to put in 9%, but that’s nowhere near enough for you to be completely self-funded and content in retirement.
If you’re reading this and are decades beyond your 18th birthday, you’ll likely need to contribute a much higher percentage to get the same result as an 18-year-old putting away the recommended 12% of their annual salary into a superannuation account.
2. What can I do today?
There are three factors that superannuation planning revolves around:
- The money you contribute
- Plus Investment returns
- Minus any fees and taxes that need to be paid
Superannuation planning can be done in hundreds of different ways, but they all revolve around these three main components. Since the biggest selling point of superannuation planning is paying less tax, your superannuation planning should reflect that.
Let’s take a look at the 2017 tax rates. You can also follow along using the simple tax calculator provided by the Australian Taxation Office.
If you are earning $85,000 a year, you will have to pay out $3,572 plus 32.50 cents on every dollar over $37,000.
For any capital gains (assets you sell for a profit within 12 months of purchase), the gains get added to your overall income and you will also pay a percentage on the dollar as well. In this example, you would pay 32.50 cents per dollar up to $85,000 total income, and then 37 cents per dollar over $87,000.
However, if you chose to contribute into your superannuation account, you would only get taxed at 15 cents on every dollar and only 10 cents on every dollar in capital gains tax.
This is the leverage the government provides its citizens for funding their own retirement, and to most, it looks very appealing. You have the option to either pay around 32.50 cents on every dollar, or 15 cents on every dollar. Sounds like a great option, right?
Well, the government definitely thinks so and has capped out superannuation contributions to $25,000 a year in pre-tax contributions so it can continue to get tax revenue from regular income.
This $25,000 is made up of the 9% of your employer contributes, and the rest is the portion of your salary you chose to contribute.
So taking this $85,000 a year job, $7,650 would be put into your superannuation account, and you would have the option to contribute the additional $17,350 to reach the limit.
For more information on the most recent changes, see our comprehensive guide here.
3. Is it worth it?
If you kept the $17,350 in your bank account, you would have to pay out $5,638.75 to the government. If you decided to max out your super for the year, you would only have to pay out $2,602.50.
The $3,036.25 you would have otherwise paid out to the government in taxes will be waiting for you when you retire and will be gathering and compounding interest every year until then. Additionally, the income earned will be taxed at 15%, as opposed to the 32.5%, and also much less risky.
Superannuation gets more and more attractive as you get older:
- If you’re over 50 years old, the superannuation contribution limit becomes $50,000
- Once you hit 60, you won’t have to pay income tax in your superannuation account
Just because superannuation starts to look more attractive for older people, it would be a huge missed opportunity to not contribute as much as you can into your super if you are still young to reap the benefits of compounded interest.
To illustrate this example, let’s use the Australian Securities and Investments Commission calculator for superannuation returns. To harp on the above example, let’s assume I’m 26 years old and decide to max out my super with before-tax contributions and no after-tax contributions.
Other than wanting to max out my super with pre-tax contributions, the above super account is pretty moderate.
As you can see from the above returns, I would have $822,218 waiting for me when I turn 67. When combined with any additional government payments at retirement, I’ve got a fairly sustainable cushion of financial support.
Please note that you aren’t going to receive a package in the mail with a lump sum of your retirement savings, it’s going to be distributed as retirement income (we’ll get into this later).
Additionally, In this 42 year period, I would have effectively saved $127,522.50 ($3036.25 times 42) by contributing to my super account.
Keep in mind that this is a moderate account. According to the same calculator above, if I chose to target a growth or high growth option, my superannuation account at 67 would be $1,003,740 and $1,092,264 respectively.
4. Does it make sense to see a financial advisor?
Yes. Although these calculators provide great insight into where your account could be headed, there is no substitute for a qualified financial advisor. These are just fundamentals to facilitate your understanding, but there are literally thousands of different ways your retirement planning can be handled.
Armed with the basic fundamentals, you will be able to enter into a meeting with your financial advisor and understand what you are doing and where your account is headed.
If you’d like to speak with one of our retirement planning specialists, book your free consultation today.
Step 3: Understand What Your Retirement Picture Looks Like
Calculating Your Superannuation Contributions & Returns
One of the most common questions Australians ask during their financial plan is “What will retirement look like for me?”
The ASIC is loaded with useful calculators to help you plan your retirement and better understand the retirement picture with your situation today. Using the same example as above ASIC retirement planning calculator takes into account your superannuation and your age pension.
With the above criteria set, I get:
As you can see above, my superannuation account combined with my age pension from the government is going to give me a $45,169 income every year until I turn 90.
At first glance, $45,169 might not look impressive, but keep in mind that this is non-taxable income, I don’t have to work for it (I already did), and it lasts me for 23 years.
Additionally, this figure is only from my superannuation account and my pension and does not factor in any additional investments I may have.
Circling back to the initial example of a comfortable lifestyle, my annual retirement income of $45,169 is hardly enough for my annual expenses of $60,400. This would require some lifestyle and spending habit changes, or a higher propensity to save and allocate towards retirement today.
The Government Age Pension
The Australian government provides a pension to citizens 65 and older (65.5 in July 2017), but the pension alone isn’t enough to live on comfortably for most people. The maximum pension for a single person is $794.80 every fortnight.
A maximum of $1,589.60 a month is a substantially different lifestyle than the monthly prorated superannuation income of $3,764.08. Additionally, your pension may be reduced based on your other investments and income.
Retirement Planning: Defence and Offence
Up until this point, we have primarily focused on how to gear your superannuation for your retirement because it is one of the best options available for Australians.
The legal tax break combined with the security of most superannuation funds make it an extremely effective way to save for post-retirement income. Ultimately, your retirement savings is based on your super and your non-super streams of income and savings.
While the above example provides more than enough for a comfortable lifestyle based purely on superannuation and pension, there are still multiple expenses that could pop up and drastically increase your cost of living.
Maybe you had another kid? Perhaps you bought a bigger house or a vacation house?
Step 4: The Defense of Retirement Planning
Calculate Your Retirement Income
Outside of your superannuation, you should focus on minimising and eliminating whatever expenses you can that are not directly correlated to your current quality of life.
One of the biggest expenses Australians incur is associated with their debt. The average Australian household owes roughly $250,000 in debt.
This debt comes in the form of:
- Mortgages (56.3% of personal debt)
- Investor debt (36.5%) e.g. investments like rental properties
- Personal debt for purchases (3.1%),
- Student loans (2.1%)
- Credit cards (1.9%)
All debt, however, is not created equal. It’s important to distinguish between good debt and bad debt.
The difference between Good Debt and Bad Debt:
Good Debt
This debt is incurred as a way to build long-term wealth. This is attached to a revenue generating or equity building asset such as buying an investment property or owning your house. If not carefully managed, and your good debt ends up costing you more than your investment yields, it could turn into bad debt.
Bad Debt
This debt diminishes your wealth in the long-term. It is not attached to a revenue-generating asset and is usually incurred by living beyond your means. Credit cards are a common example of bad debt that Australians struggle with.
Having bad debt weighs on your finances as you near that retirement age, ultimately taking away from how much money you can enjoy when you retire. If it is not fully paid off by the time you retire, a significant portion of your income could go towards paying off debt from years ago.
The majority of the average Australian’s personal debt is defined as good debt (56.3% for home loans and 36.5% for investments), but the 8.2% of debt considered as bad debt can do enough damage on its own. If each household owes $250,000, then $20,500 of it is considered bad debt.
Since good debt is usually paid off through the investments it is used to purchase either in the short term or long term, it will eventually be taken care of.
Bad debt, however, since it is not tied to a revenue producing asset will continue to incur interest until it is paid off from your other streams of income.
For example, if this $20,500 of debt is accruing interest at a rate of 15% and you plan to pay it off in 10 years, you will have paid $19,148 in interest in addition to the original amount of $20,500. This calculator is helpful to calculate how much you can expect to pay in interest.
In order to pay off your debt so you can commit more money towards your superannuation or other long-term investments, it is helpful to come up with a budget that goes towards paying it off.
Step 5: The Offence of Retirement Planning
Learning To Put The Planning Into Action
When it comes to investments geared towards your retirement outside of your superannuation account, one must be very careful. Since the government offers a substantial tax break for the money you’ve put into your super, it usually makes more sense for people to max out their annual super limits before looking at other investment opportunities.
Once this account is maxed out, however, there is a multitude of different investments that will yield a far better return than whatever infinitesimal interest your money would be accruing in a savings account.
The options, however, largely depend on your risk tolerance and cash liquidity preferences as mentioned above. This is why it is extremely important to meet with a financial advisor when it comes to planning to invest, especially for the long-term.
According to Moneysmart.gov.au, long-term investments outside of superannuation that have the following criteria are targeted by investors:
- Risk – high, with negative returns, expected 4-5 years out of 20 years
- Volatility – high; capital value could go up or down by 40% in a year
- Expected return – 8-8.5% per year (on average over 10+ years)
The type of investment that works for you could be anything from investment properties to mutual funds, so it’s important to discuss what your expectations are with an experienced financial advisor for the better guidance.
Final Thoughts
Planning your retirement is great but taking action is best!
These steps are a start to preparing for a comfortable retirement but are only meant to provide a foundational knowledge. The calculators within this guide are a great way to conceptualise the direction you want to go and can be enlightening to what steps you should take to adjust course to get there.
The sooner you start planning for retirement and allocating capital, the more it will compound and earn you in the future. When it comes to setting up your retirement plan, debt payment budget, external investments, and your overall financial plan, make sure to meet with a financial advisor to start converting knowledge into action.