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. But the most common question we are asked is:
How much money do you need to save for retirement?
When you are in your 20s, 30s and 40s, you need to build your savings. Those in their 50s and 60s must find the resources to continue to build savings and accumulate wealth as they prepare for life after work. 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 for life after work 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 without your usual income. The Association of Superannuation Funds of Australia (ASFA) retirement standard found a couple looking to have a comfortable post-work lifestyle 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 leave work. 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 post-work lifestyle. The table also outlines different categories and the type of lifestyle you’ll be able to live. It applies to people leaving the workforce at age 65 who will live to an average life expectancy of about 85.
Your Timeline to Retirement
Just like what type of lifestyle you are expecting in the future can affect how much you need to save, so too can your timeline to retirement.
Your timeline to retirement – or the time left between your current age and at what age you’d ideally like to leave the workforce – can have a large impact on whether or not you’ll be able to achieve the post-work lifestyle you’ve always dreamed of or whether you may need to rethink your expectations for what your ideal retirement may look like.
For example, if you are in your mid-to-early-20’s and are expecting to leave the workforce around the age of 60, you have ample time to implement good savings habits that will ensure you’re able to achieve your dream future lifestyle. However, if you are in your 40’s or 50’s and are expecting to leave the workforce around 65, this leaves less time for you to implement the number of financial strategies that can assist you in achieving a comfortable retirement lifestyle.
Your timeline to retirement can also affect the other strategies you may choose to utilise when working towards achieving the amount you need for your ideal post-work lifestyle. For example, if you are closer to your desired retirement age, you may have to voluntarily contribute higher amounts of your income to your super to ensure you’re able to achieve your post-work income goals.
If you’re unsure of what your particular timeline to retirement is, or how it may affect the amount of money you can save, your financial advisor will be able to work with you to clarify this information. They’ll also be able to provide you with a clear understanding of any gaps that may exist between your current financial situation and your future goals and create a plan to help you bridge them.
The Two-Thirds Rule
Another way to estimate how much money you will need for the future is to assume you need 67 percent (two-thirds) of your income saved before you leave your job in order to maintain the same standard of living you enjoy now. 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.
How To Calculate How Much You’ll Need To Retire
A common rule of thumb is that if you want to leave the workforce 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 leave the workforce soon, a good back-of-the-napkin estimate is to have a retirement portfolio that’s roughly 25 times the value of your annual post-work 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 future 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% Rule
The 4% rule is likely the most common, cookie-cutter technique in retirement-income projections. This approach applies a 4% 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 post-work life. 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% inflation rate, you’d withdraw $82,400 in year two, then $84,870 in year three, etc. The research behind the 4% rule suggests that during the past century, investors would not have exhausted their assets during any 30-year period. The criticism of the 4% 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% and can go as high as 5.7%. For a more conservative investor, the rate starts at about 3.9% and goes as high as 5%.
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 post-work 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 a bright future requires expert help and the sooner you speak to a professional about life after work the faster you will be on track to working on the right plan for your lifestyle and situation.
If you require expert advice or additional information about retirement, don’t hesitate to get in touch with the team.