Retired actuary John De Ravin has written the ultimate ‘guide’ book for managing money and planning the best possible retirement. In this extract from Slow and Steady: 100 wealth building strategies, he explains how to answer that tough questions – how much do I need?
Read this strategy if:
- you are approaching retirement and need to estimate your annual spending to provide the lifestyle you would like in retirement (as a prerequisite for calculating the total amount of money you need to have to retire comfortably).
When you approach retirement, it is natural to consider whether you have ‘enough’ in superannuation and other financial assets to enable you to live the lifestyle that you envisage in retirement. The starting point for this calculation needs to be a slightly simpler question: How much will my desired retirement lifestyle cost?
The Association of Superannuation Funds of Australia (ASFA) has developed a Retirement Calculator into which you can put the following details:
- single male/single female/couple
- state in which you intend to retire
- desired lifestyle (‘modest’ or ‘comfortable’)
- budgeting frequency (annually/quarterly/monthly/fortnightly/weekly).
The calculator will then return an amount to support your target lifestyle.
Although the ASFA retirement standard is a helpful indicator, it doesn’t really allow for the range of different lifestyle expectations that people may have in practice, apart from the simple ‘modest versus comfortable’ binary comparison. In practice, some retirees will expect a much higher standard of living than what is implied by the ASFA ‘comfortable’ standard, while others might find the ‘modest’ standard very acceptable. Also as we age, we tend to spend much less on some expense categories such as travel and entertainment, though this decrease may be partially offset by higher medical and care expenses.
It is a good idea to estimate how much you will spend as the basis of retirement planning. The best way to do this is to apply a two-step process:
1. Work out what your lifestyle costs before retirement.
2. Make adjustments for expected differences between your lifestyle while you are still working and the lifestyle you plan to lead while retired.
Alternatively, you can ‘start from scratch’ and use a budgeting tool to estimate the costs of your retirement lifestyle. But this is a bit harder because it isn’t ‘anchored’ to the actual costs of your current lifestyle and it is easy to omit some components of expense (especially infrequent expenses and capital items that need replacement at the end of their useful life) due to oversight.
How to do it
The first challenge is to work out what your current lifestyle costs, if you don’t already know. Assuming that all your income flows into bank statements, then you can review your bank statements over the course of (say) the past year. Your outgoings will be in the nature of:
1. living expenses
2. transfers to other accounts (such as credit card accounts) to pay off living expenses
3. purchases of investments
4. transfers to other accounts to purchase investments
5. mortgage loan repayments
6. personal loan repayments.
Your annual living expenses are the sum of all items in categories 1 and 2 above, but you should exclude items in categories 3 to 6 on the assumption that by the time you retire you will have paid off all your mortgages and personal loans.
If you have more than one account from which you meet living expenses, you can add up the items across the various accounts but, of course, any transfers between those accounts should be excluded to avoid double counting.
If you have large non-recurring expenses, which you are sure will not arise again in retirement, then you should exclude those items from your living expenses. (For example, if you contributed $25,000 towards the costs of the wedding of your last remaining single child, you should not include $25,000 as part of your annual living expenses or you will arrive at too high a figure.)
The second challenge is to adjust your current expenses to adapt to your post-retirement lifestyle. This means that you will need to:
Remove or reduce any expenses of activities that you will be doing less of (or not doing at all) in retirement, for example:
- the cost of dry-cleaning your work clothes
- the cost of transport to and from work
- any other work-related expenses that you had to meet.
- Insert or increase expenses for activities that you will be commencing, or doing more of, in retirement, for example: increased travel costs, if you plan to travel more domestically or overseas in retirement compared to what you did while you were working
- increased leisure costs, because you will now have a lot more time on your hands – you will need to do something to occupy yourself for all the time that you used to be at work.
It will probably be easier to identify the costs that should be reduced or removed from your lifestyle budget. It may be harder to know what additional expenses you are likely to incur before you actually commence your retirement.
Instead of analysing your historical expenses, an alternative is to build a budget for your new retirement lifestyle using a budgeting tool available from various apps or websites. A good example is the ASIC MoneySmart website, which is easy to operate and produces an immediate summary that you can print or save under your chosen name (such as ‘Planned Budget 2017’). You will need to create a MoneySmart account to save your workbook but that is very quick and easy to do. You can then log in later to retrieve your saved budget from the MoneySmart website. Alternatively, you can download the Excel version of the MoneySmart budgeting tool and save that directly to your own device.
The MoneySmart website also has a simple money manager, which abbreviates the budgeting process to 14 headings – three for income and 11 for outgoings. The money manager also includes audio to help you complete the budget, and the audio is available in nine different languages.
What does it mean for you financially?
Creating your own budget is the starting point to knowing how much you need to have saved in order to retire. It means you can now start to consider questions such as:
1. Can I retire now?
2. When can I retire if I want to have $X per year to spend in retirement?
3. How much money do I need to have to retire and live the lifestyle I expect?
If you don’t know how much it will cost you to live in retirement, you are at risk of either retiring too soon and finding that your money is likely to run out, or staying in the workforce, which you might not enjoy, when in fact you could afford to live the rest of your life comfortably with the lifestyle you want, without needing to keep earning.
Slow and Steady is available from John De Ravin’s website for $39.95.
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