Life expectancies continue to rise, and with that comes a host of challenges. For governments, there’s the increasing cost to budgets and, for retirees, there’s the uncertainty of how long they can expect to live.
To make it even more complex, Australia has a unique retirement income system. In many countries, you could be guaranteed some sort of a pension, usually indexed, for as long as you live. But our retirement system is based around a lump sum superannuation fund, with the retiree drawing an account-based pension from that fund.
This highlights the next challenge. To ensure your money lasts as long as you do, it’s wise to invest a big chunk of your assets in growth investments such as property and shares. But these by their nature have ups and downs, which leads more inexperienced or risk-adverse investors to favour cash-based investments where, historically, returns have been much lower. To make matters worse, interest rates are at a record low. This makes cash and bonds extremely risky assets in which to invest.
The result of all this? Most retirees are reluctant to spend as much as they could. They are too scared of running out of money and/or having insufficient funds to get quality aged care in the later years.
The government is well aware of this, and four years ago put the retirement industry on notice to develop products that would solve the problem of running out of money.
These were to be known as Comprehensive Income Products for Retirement (CIPRs) and worked on the premise that retirees would invest a portion of their superannuation into a product, which was to be held separately, to provide an annuity if and when the retiree reached 85 years of age. The theory was that retirees could then spend with confidence knowing that if they did reach 85, an income would be available to them. This is still a work in progress.
The process went to the next step with the then government announcing new means test rules for ‘lifetime income streams’ purchased on or after 1 July 2019. From that date, only 60 per cent of the purchase price is assessed for the Age Pension assets test up to age 84 (or for a minimum of five years) and 30 per cent thereafter.
As well as providing increased flexibility for retirees, they can be highly effective in maximising Centrelink benefits in some circumstances. They are complex, so if you are considering investing in them, get expert advice.
That’s the background, but the question on most pre-retirees’ lips is: how much money do we need to retire?
There is no simple answer, as people’s spending habits vary enormously, and a heap of variables – such as how long you will live and the state of your health – come into play. Even so, it’s worthwhile doing some calculations as a guide for future strategies. Here’s how to use the calculators on my website to design your retirement future.
Think about a couple, both aged 62, who wish to retire at 66. They own their home, and their financial assets on retirement should be $500,000 in super and $80,000 in bank accounts. For Centrelink purposes, their furniture and motor vehicle would be worth $20,000.
Their first step is to do a budget, to get some idea of their living costs now and when they retire. The ASIC website, moneysmart.gov.au, is a fantastic resource that shows how to prepare a budget and also provides useful calculators.
The couple’s present spending needs to be adjusted for retirement, eliminating items such as travel to work, bought lunches, work clothes and union fees. Two-car families should also consider whether they could reduce their costs by having only one car in retirement.
This exercise can be challenging; you have to accept that there are some items for which you can make a reasonable estimate, and others that are at best a good guess, because the final outcome will be known only in retrospect.
After doing the budget, our couple decide that $65,000 a year – in today’s money – would give them an adequate retirement income.
Their next step is to go to my future value calculator and convert that sum to its value in four years. We’ll apply an inflation rate of 4 per cent. The answer is $76,100, which can be rounded down to $76,000.
Next, they need to work out their Centrelink entitlements. Using my deeming calculator, they enter their financial assets, superannuation and bank accounts – all of which are subject to deeming. The sum of $580,000 produces a deemed income of $434 a fortnight.
Next, they go to the Age Pension calculator and enter income of $434 and assessable assets of $600,000. The result will be a pension of $682 a fortnight each under the income test and $414 each under the assets test. Centrelink uses the test that gives the lowest pension, so they should be eligible for a total fortnightly pension of $828 or $21,500 a year.
We now have specific data. Their expenses should be $76,000 a year, and the pension will provide $21,500 of that. The shortfall is $54,500 a year.
To complete the exercise, simply go to my retirement lump sum calculator and enter $54,500 as the yearly income needed, using an indexation rate of, say, 1.5 per cent, an earning rate of your choosing and how many years you need your money to last. The calculator will tell you that a lump sum of $769,700 would be necessary to provide an indexed income of $48,500 a year, at an earning rate of 7 per cent a year. This assumes all funds will be exhausted after 25 years.
It’s important to understand that these numbers are not cast in stone – and you need to review your situation at least once a year to see if you need to adjust your strategies. Also, some people will receive bequests when their parents pass on, and these numbers should be factored into the calculations.
What this planning does is give you a chance to consider whether you need to boost your superannuation by working a little longer or reduce your planned expenses.
Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance.
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Disclaimer: All content in the Retirement Affordability Index™ is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.