When you no longer have a job topping up your bank account regularly, working out your spending in retirement is quite a challenge. It’s a big mind shift that many people struggle with.
A friend of mine, consultant Stephen Huppert, compares the switch from saving for retirement to drawing down savings for spending in retirement as like a cyclist’s switch from riding up the hill to riding down it. The downhill is more unknown, uncertain and risky. It requires a change in thinking, lest you go over the edge.
In the Tour de France, riders often get up to speeds of 110kph on the downhill sections. Terrible accidents sometimes occur, as in 2017 when Australian Richie Porte lost control at 120kph and fractured a collarbone and a hip.
Now, retirement shouldn’t be that scary! You’re looking for peace of mind, not thrills. Still, it does require a change in thinking.
The change is hard for a number of reasons.
First, you’ve spent maybe the past 30 or 40 years saving for retirement, watching that nest egg grow. That felt good, to see the progress you’ve made. You’ve just been able to leave it there and let good markets, compound earnings and your contributions make it bigger. It’s become a pile, most likely larger than you’ve ever had before.
But now, you’ve got to switch to using the pile to fund your retirement living. You’re going to have to draw it down to get yourself what you might call a ‘retirement salary’. The pile’s probably going to shrink … well, that doesn’t feel so good – does it, Uncle Scrooge?
Second, you’ve got to work out just how much you can afford to take from the pile. That’s not easy because you want to have enough money to live comfortably and you want it to last your lifetime. And you don’t know how long you (and your partner) are going to live or what investment returns you’ll earn. Who knows what the financial markets will do in the years ahead?
Third, you’re also probably looking for some help from the government’s Age Pension, either now or in the future. How do you factor that in?
How much you can spend in retirement is actually very complicated. It’s like the problem of how much water a farmer should use to irrigate his crops and still last the long hot summer. It’s the type of problem actuaries get paid big money for solving. But you don’t have an actuary in the family, do you?
How to be a good downhill rider
There are a number of things you can do to find peace of mind in the drawdown phase.
First, make the mind shift. You’re not Scrooge and the point isn’t to die with a big pile of money.
We often see that type of behaviour in real life. Australian Bureau of Statistics figures show that savings for retirees typically rise as they get older and many die with large sums, leaving the money to heirs. They’re underspending compared to what they can afford. It’s most likely due to the natural human fear of running out. Result: we underspend.
As my co-director at Retirement Essentials, Professor Deborah Ralston, says: “People often overestimate the potential costs of health and aged care in their later years. But there’s a lot of government assistance for that. And so many people reduce their spending below a comfortable level as a precautionary measure.”
Second, get your Centrelink entitlements in place as soon as you’re eligible and look to make the most of them. The Age Pension is a fabulous asset for senior Australians. The maximum Age Pension is now $37,000 per annum for a couple and $24,500 for a single. It’s reviewed semi-annually, based on the cost of living and, until this September, increased in each of the past 70 years. And it lasts a lifetime. You can check your Age Pension eligibility here.
Even someone who’s not eligible now for the Age Pension – maybe due to having too much in assets – may well become eligible later in life as savings are spent down. So, it’s a great safety net – effectively meaning that the floor on your retirement income is the maximum Age Pension.
Third, understand your planning horizon. We Australians are living longer than we think. The average man’s life expectancy at age 65 is 85 and the average woman’s is 87. However, that means that about half the people will live longer than that. So, unless you’re not healthy, planning to live into your 90s is probably a safer bet than planning on your 80s. For example, for a couple both currently aged 65, there’s a 24 per cent chance that one person will still be alive at age 95.
And recognise you could live to be 100 or more.
The chart below shows a case study illustrating the impact of long living on what you can afford to spend. It’s for a couple, both aged 66, who have $500,000 between them in financial assets. The longer they are expecting to live, the less they can afford to spend each year. If they were only going to live until 75 – or were prepared to live entirely on the Age Pension after that – Retirement Essentials estimates they could spend $81,900 per year. But if they were planning for a horizon of 90, then $56,400 per year would be a more reasonable expectation. And if planning for 100, then $51,800 would be suitable.
Fourth, work out how much you need and how much you’d like to spend. Everyone has basic needs – we call that your ‘required spending’. And everyone has some extras they’d like, whether including travel or entertainment or gifts for the grandkids. We call the total of ‘required spending’ and the extras ‘desired spending’.
It may well turn out, too, that you’ll want to spend more in your earlier years of retirement and less as you get older. That’s the general pattern in Australia. Average spending tends to decline as people get older. Each quarterly edition of YourLifeChoices’ Retirement Affordability Index tracks changes in the estimated cost of living for three cohorts – the affluents, constrained and cash-strapped retirees – through a formula developed by The Australia Institute. Australian Super Funds Association also publishes its ‘modest’ and ‘comfortable’ living standards.
Keeping control of your budget is a key task for retirees. It’s tough to go out and make up gaps with a part-time job as you get older, so keep good tabs on what you are spending.
And don’t forget to plan for unexpected and lumpy costs – such as a major repair on the house or a new car at some point. It’s always good to keep six months or more of emergency funding available, in case you need it.
One other thing, if you’re retired (over 60) and still in an accumulation super account, you should consider the advantages of an account-based pension. Many people let inertia carry them along and just stick with the regular super account, which is taxed at up to 15 per cent on investment earnings.
At Retirement Essentials, we find almost 30 per cent of our Age Pension clients are still in accumulation super, whereas earnings on an account-based pension, which is designed for the drawdown phase, are tax free – leaving more in your pocket.
It takes a bit of effort to make the move, but it’s usually worthwhile.
You can see there’s quite a bit to this drawdown phase. With a bit of careful planning – and maybe some professional help from a financial adviser – it can be a safe and enjoyable ride on an easy downslope.
Were you able to ‘flick the switch’ from saving to spending? Or do you think you’ll be able to do that easily when the time comes? Is there enough support to make this transition?
Jeremy Duffield is a senior executivein the Australian and international financial services sectors. He is the chairman of Retirement Essentials, which assists people to apply for the Age Pension, and of SuperEd, which is focused on helping super fund members plan for their retirement.
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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.