Why Retirement Planning Isn't A Last Minute Job
In life there are certain things that we all avoid to the last minute or in some cases put off all together. I have to admit that personally I am one to put certain household chores to the absolute bottom of the to do list (packing before a trip is also always a last minute exercise, ask about my last trip for the IFA advisory awards and how I somehow managed to pack nothing I needed).
There are certain things that we can’t put off forever and although they might not be the most enjoyable to do, like eating making the kids eat vegetables, we know we have to do them for the betterment of our future.
For many people, retirement planning is something that you push back until you are 50 or maybe 55, however unlike finally getting around to cleaning the garage out this is one that you can not afford to wait to do.
The Australian retirement system is potentially the greatest one in the world, with many leading global financial authorities and fund managers expressing desires for their own country’s to replicate our systems.
Our retirement system is based on 4 key pillars.
1. Home Ownership. As we all know property can be creator and store of wealth. Not only does owning a mortgage free home in retirement significantly reduce your living cost but can provide additional financial flexibility in retirement if you are happy to downside
2. Superannuation. Compound interest and compounding returns are some of the greatest forces in the financial world. Our system of forced saving enables Australians to invest with a long term horizon for when they are ready to hit the golden years.
3. The Aged Pension and Social Security System. Unlike many countries, whilst not perfect, the Australian Aged Pension system does help to provide a safety net and improve standards of living in retirement.
4. Holding investments in vehicles outside of Superannuation such as your personal name, Family Trusts or businesses.
One of the key questions that always comes up during retirement planning is trying to establish exactly how much you will need to have across available funds, income producing assets and capital gain focused assets by the time you hit retirement.
With this one is not an exact science because as you know financial markets, government policy and the world as a whole is changing at a rapid pace.
In fact, if you knew that you were going to retire at 60, die at 70 and spend $50,000 a year it would be pretty simple to work out how much you will need. You would need $500,000 and happily be able to hold that in cash (avoiding all market, timing and investment risk) spending as you go.
However, in the real world, no one knows when they are going to pass and as we are experiencing an ever-aging population it is a safe bet to assume that you are most likely going to live longer than you expect. Modern science is amazing and life expectancy has experienced a significant uplift since most of us were born.
When it comes to determining exactly how much you will need in retirement savings you (or your financial professional) will need to consider the following variables:
1. What quality of lifestyle and retirement living do you desire? According the Association of Superannuation Funds of Australia for a couple to live a comfortable lifestyle they will require an income of $62,828 per year and for singles this is $44,412 per year. Assuming that you would be able to access to a partial Aged Pension a couple would require $640,000 in retirement savings and $545,000 for a single person.
2. The level of income and returns that you require in retirement to meet your income needs. Additionally, in the modern investment world the income yield on safer asset classes is at near historical lows (with the Australian 2-year bond yielding only 0.1%) many investors have had to move to asset classes such as shares and property to meet their income requirements. This does bring in additional volatility and market risk to your portfolio and may not be appropriate for investors with a lower risk tolerance and shorter investment time frames.
3. Will you need to budget for any significant expenditure? For example, my parents are looking to travel extensively in their retirement. This is going to require significantly more money then if they were happy to sit at home. The timing of these drawdowns can have significant impacts upon the quality of your retirement.
4. The tax and pension implications of your investments. Various asset classes and the underlying investment vehicles may have an impact upon your requirements to pay tax (or receive the retiree’s favourite Franking Credits) but also may impact upon your ability to access an Age Pension.
One of the easiest ways to boost your retirement savings and income in retirement is by utilizing popular salary sacrifice contributions to superannuation. In the example below you can see how consistent additional contributions combined with a long term time will make to an individuals retirement savings. Assuming you are a 40 year old making $100,000 a year plus superannuation payments with a starting balance of $150,000 in super with administration charges of $500 per year, investment fees of 0.85% and a long term average return rate of 7.5%, you would be on track to retire at age 65 with $573,665. However, if that same individual was to salary sacrifice $160 of pre tax income per week into their superannuation until retirement the balance would grow to $813,206
The difference in total retirement balance is nearly $240,000 or an annual overseas holiday!
Unlike cleaning out the garage, there really is no better time to start planning and preparing for your retirement than today.