It's the big question when it comes to retirement: how much money do you actually need to retire comfortably? Unfortunately, there is no simple rule of thumb to generate an answer.
The essential dilemma is everyone’s situation is different. Most obviously, we all have different financial situations, but there’s also the great unknown of how long we will live – which is crucial to understanding whether we can comfortably fund our retirement. The average life span is lengthening, and “longevity risk”, a previously obscure term, is now front of mind for many retirees. The longevity risk is that you will run out of money before you die.
The good news is that there are some key strategies that can help you get at least a ballpark picture of how much you will need in retirement.
When you’re saving for retirement, it can be hard to envisage how much you actually will need – so benchmarks can be helpful.
Graham Fletcher, Senior Financial Adviser at Australian Unity, says the Retirement Standard of the Association of Superannuation Funds of Australia (ASFA), which is updated quarterly, is a helpful tool. It estimates how much money is needed for a “modest” and a “comfortable” lifestyle for people retiring at age 65 who will live to an average life expectancy of about 85.
The ASFA standard assumes the retirees own their home outright, and are relatively healthy. A “modest” retirement lifestyle is considered better than the Age Pension would allow, but still only covers basic activities. A “comfortable” retirement lifestyle allows a retiree to be involved in a wide range of activities and to have a good standard of living that allows them to afford things like private health insurance, a car, and occasional holiday travel.
As at the March quarter 2020, ASFA says a modest lifestyle for those aged around 65 involves spending $28,220 a year for a single person, and $40,719 for a couple.
For the same age group, a comfortable lifestyle can be funded with $44,183 a year for a single person, and $62,435 for a couple.
These amounts change with age. ASFA says for those aged around 85, a modest lifestyle can be enjoyed for $26,769 a year for a single person and $38,285 for a couple; an upgrade to “comfortable” for 85-year-olds implies annual spending of $42,158 for a single person and $58,491 for a couple.
“The ASFA standard is helpful to give people a basic idea of costs, although retirement spending is very individual. People have different things they want to do, like travel, or maybe moving to live somewhere else,” says Graham.
Although the ASFA standards work well as a starting point, Graham says the amount of money a person will need in retirement will depend on a variety of parameters – and that amount may not be what they expect.
“It depends on an interplay of factors, and it’s highly personal. About 90 percent of the people we advise say they would be comfortable to retire on what they’re earning now. But if a lot of that income is currently disappearing on mortgage payments, kids’ expenses and whatever else, it’s not your real spending level. Knowing your spending is going to be important in retirement.”
Graham explains that one of the best tools for identifying your spending level is that faithful standby of personal finance: a budget.
“We ask people to do a budget to identify how much they are actually going to need to spend, cutting out those extra costs that are no longer going to be relevant. That often gives people a good starting point,” says Graham.
“Quite often people are surprised to find that they have more money in retirement, because some of their spending is no longer relevant – home loans, commuting costs, and so on. Suddenly, they’re not scrimping and saving as hard as they thought they would be.”
Once you know what your spending looks like, you can start to identify what you’ll need to fund that level of spending. Again, this will be different for everyone.
“It’s often a combination of self-funding your retirement from super, possibly the sale of your house, and possibly some government support, such as the Age Pension. This is balanced against your level of savings, your investment return and your desired income,” says Graham.
The ASFA Retirement Tracker Calculator is a helpful tool to check whether you are on track to fund a “modest” or “comfortable” retirement.
However, depending on your spending level and your ability to fund your retirement, you may need to make some adjustments.
“People often underestimate their ability to adjust their spending habits to match their income. But where we see a level of spending in retirement that outmatches the capital, we’ll recommend that spending is lowered. Usually that is a safer adjustment rather than taking unnecessary investment risk trying to increase the available capital,” explains Graham.
The earlier that you start to think about your retirement funding needs, the better.
“It means you’ll have more flexibility,” says Graham. “If you start planning late in the piece, your retirement income will be driven by what you’ve saved. If you want to retire at 65, and you’re starting to think about retirement income at 63, your most pressing question is going to be, ‘I have $X, how much can it provide me?’.
“Whereas, if you start planning in your early 40s, or even late 30s, you then have the option of working out roughly how you would like to live, what that lifestyle looks like in dollar terms, and you can start to make a realistic plan about how you’ll be able to finance that.”
It just goes to show that with a little forward planning you can nail a realistic retirement number well in advance of when you plan to stop working – and live the retirement you have always dreamed about.