How much Capital do you need for retirement?
Determining what amount of capital you require to retire is one of the most important financial decisions you make. It frames your long term wealth accumulation goals and acts as a virtual goal post for financial management.
With continued advances in medical science we are living longer than ever before. This generally means we require more capital to retire than past generations, and the reality is many of us will need to work longer than previous generations to save these larger capital amounts.
There is no hard and fast rule on how much capital is required to fund your retirement income goals. However, there are various competing methodologies that act as a guide to retirement goal setting.
Snowgum Financial Services Approach
We aim to develop a financial plan for clients which will provide enough funds in retirement to allow clients to live the lifestyle they aspire to. To do this we begin by focusing on what our clients expect their retirement incomes to be in today’s dollars. Once this retirement income goal is set we calculate what investment capital will be required to generate this income.
This is calculated by using a formula which takes into consideration a number of variables such as CPI and how the funds are invested with a resultant rate of return.
By taking this approach for individuals who have the capacity to accumulate substantial wealth, we provide an ambitious but attainable goal that, when achieved, will afford a comfortable retirement. This calculation is formulated as a perpetuity type of calculation and upon attaining this capital value, irrespective of your age, you will be in a position to retire. Depending on your income and capacity to save, scenarios can be developed that will allow you to retire, if you wish, well before the government’s set retirement age.
The capital goal, and most importantly the maintenance of that capital and the resultant retirement income, is significantly affected by the choice of asset classes and the choice of investments within those classes. The importance of this selection is highlighted in the example below.
Assuming 3% inflation throughout retirement, if you wish to maintain an income in retirement of $200,000p.a, and you invest in an assertive manner yielding a net rate of return of 7.5%p.a.,the investment capital required at retirement is $4.4 million.
If we alter your rate of return to a conservative portfolio yielding 5.0% p.a., the investment capital required at the start of retirement is $10 million.
This example highlights the importance of setting a capital lump sum requirement for retirement to act as your goal post, and then developing an attainable and realistic plan, and most importantly why a concerted approach to wealth accumulation planning, and one’s spending habits, is essential. It also highlights that selecting the right asset classes to invest in is a critical part of retirement planning.
Standard of Living Guide
The Association of Super Funds Australia (ASFA), regularly reviews cost of living standards and publishes guidelines on a quarterly basis for what represents a modest and comfortable retirement income level. The table below outlines these figures for the December quarter 2014.
ASFA estimates the lump sum needed to support a comfortable lifestyle for a couple is $510,000 (or $430,000 for a single person) assuming a partial Age Pension. ASFA also estimates that because a modest lifestyle is mostly met by the Age Pension, the lump sum required to support it for a couple is $50,000 ($35,000 for a single person).
However if your income, and how much you spent annually, was well above these figures throughout your working life then these ASFA guidelines will be well below what you might need to continue in retirement the lifestyle you are used to living. So we would like to stress again determining what amount of capital you require to retire is one of the most important financial decisions you make.
Income Savings Guides
There are a number of authors who have theorised about how much of one’s salary should be saved to maintain your pre-retirement lifestyle in retirement. Alicia H. Munnel (director of the retirement research centre) for example estimates you should be saving and investing approximately 16% of your salary throughout your working life. Fidelity Brokerage Services LLC recommends that individuals accumulate for retirement a capital amount that is 8 times their pre-retirement income.
The Australian government is aiming to lift compulsory superannuation contributions to at least 12% (from the current 9.5%) by 2025. It is likely that in time those contributions will rise to 15% in an effort to make as many Australians as possible self sufficient in their retirement, and living at a standard they would be comfortable.
It is of course difficult to define how much is enough to be comfortable, however Munnel explains that lower income households usually need to save less for retirement than higher income households. Apparently higher income earners tend to live a lifestyle undertaking more expensive activities in their free time, and in retirement, when they have more free time, they increase their expenditure on these activities. Therefore the savings goal for retirement for these higher income earners is usually greater than for others in the community.
For further retirement reading resources you can access Munnell's research at http://crr.bc.edu/wp-content/uploads/2014/07/IB_14-11.pdf