Retirement saving can be likened to the federal budget.
You can target a reasonable number and hope it all works out but it will invariably be wrong (either better or worse) because the amounts you will eventually have and need are uncertain and at the mercy of a host of variables.
The key is not to be too wrong about it.
On that note, the level of confidence you want in your planning is one of the key factors that determines how much you’ll need to save. That is, do you want your retirement finances to be robust and able to cope through a wide range of potential future outcomes relevant to your circumstances (something akin to an educated guess) or figures plucked from the sky?
According to the Association of Super Funds of Australia, a couple retiring at age 65 will need an annual income of around $58,000 to fund a ‘comfortable’ retirement.
ASIC’s Moneysmart Calculator tells us this will require a super balance of around $1 million if you are in the ‘conservative’ investment option and if you both die at around 90 years old. It’s not an unreasonable suggestion, but it’s a long way from certain that it will be enough for you.
To start with, ‘comfortable’ is different for all couples. For some, $58,000 may be plenty but others may need a lot more, or a lot less, to be ‘comfortable’. Personal factors like health, the ability to continue or resume working and likely inheritances will also have a big impact on how much income you’ll need in any particular year.
Your longevity is the next consideration. Retirement planning is frequently based around life expectancy – the forecast age to which the average person will live. This is far from a certain target – you might end up living much longer than this, or you could be hit by the proverbial bus tomorrow.
But, even if you budget on living until your late nineties (most don’t) there’s a chance your planning won’t work out as you may be around longer than you anticipated.
Finally, you need to work out how much risk you’re willing to take with your retirement planning.
You can increase your forecast annual income to $63,000 by changing your risk profile from ‘conservative’ to ‘balanced’ on the ASIC calculator but it’s important to understand that this is simply a forecast or best guess and by no means a guaranteed outcome.
Moving from ‘conservative’ to ‘balanced’ increases the best guess level of income, but it also increases the risk of earning a much lower income. It’s the nature of investments that whilst taking on more risk generally generates higher returns the reality is the riskier investments also have a much wider range of possible outcomes (positive and negative). It’s like driving from your house to the beach; if you obey the speed limit the whole way, you know roughly how long it will take and expect to get there in one piece. Making the same journey at double the speed limit reduces your forecast travel time but also increases the risk that you spend 15 minutes talking to a police officer, or don’t make it at all.
To be clear, we’re not canning retirement calculators; all retirement forecasts are at least to some degree, educated guesses. It’s the probability of success that varies. The lesson is not to make the mistake of assuming any projection is set in stone, no matter how precise the calculations or diagrams look, and to realise higher expected returns come with a price, that is a greater chance of falling short of the forecast.
If you’re relying on a retirement calculator make sure you’ve taken a good look under the bonnet and understand the assumptions on which the forecasts are made. There are so many variables that could compromise your plans including living longer than expected, needing to spend more than anticipated, or poor investment returns.
ASIC’s MoneySmart Calculator allows you to change the default forecasts in order to assess the impact of the underlying assumptions. For example, changing a couple’s life expectancy from 90 to 100 increases the required savings for a ‘comfortable lifestyle’ to $1.8 million. And to get a couple’s forecast income to $70,000 per year (with the longer life expectancy) ASIC says they’ll need more than $2.7 million.
Mind you, that’s based on a ‘conservative’ investment risk profile. Changing the risk profile to ‘moderate’ pulls the required savings back to around $2.25 million and if you’re prepared to take on a ‘balanced’ risk profile you can get the amount back under $2 million – albeit with far greater risk that your retirement planning fails miserably.
Everything comes down to risk and if you think a six-figure super balance is plenty to retire on, you better make sure you are completely comfortable with the assumptions used to work that figure out. If they don’t match your anticipated lifestyle or appetite for risk, your savings could fall a long way short of the mark.
You’ll need to act now if you want a better, less risky retirement. The only good solutions are to save more in the first place, extend your retirement date, or reduce spending.
If you dream of an early retirement, then go for it; life isn’t all about dollars and cents. But when you ask ‘how much money do I need to retire on?’ the answer should be based on a firm understanding of whether you’ve got ‘more than enough’ or ‘barely enough’. Don’t make the mistake of assuming certainty where there is none.
Richard Livingston and Annika Bradley represent the online financial advice service Eviser. This article contains general investment advice only (under AFSL 469838). This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs.