Most people struggle to quantify how much money they will need in retirement or how much they need to be doing in order to prepare for a comfortable retirement. It's not particularly difficult to work out but most people haven't been through this simple exercise. If you have 10 minutes and a smart phone, we can work it out for you right now!
How much income will you earn from now until retirement?
Start by taking your current net salary and multiply by the number of years you expect to have remaining in the workforce. Let's take a young couple who have net household income of $80,000 per annum and expect to retire in 30 years.
$80,000 x 30 years = $2,400,000
How much will you spend in retirement?
Next, take your current living expenses and multiply by the number of years in retirement. Average life expectancy in Australia is 80.4 years for men and 84.6 years for women. It’s a good idea to add 10 years on top of your life expectancy to ensure you have some buffer and because the statistics used are simple averages.
Similarly, use an accurate estimate of your living costs. If you will retire debt free then you should exclude any debt repayments. For guidance, a couple living a comfortable lifestyle will need $60,000 per annum although you may have more modest means or expectations.
$60,000 x 30 years = $1,800,000
How much do you need to save between now and retirement?
Using the calculator from the ASIC MoneySmart site, you can calculate given a savings goal, time frame and annual compounding return how much you would need to save each month to achieve your goal.
Based on the example above, $25,800 needs to be saved each year based on a conservative 5% rate of return. 5% might seem like a low rate and it can be tempting to increase or over-estimate the anticipated return to make the savings figure more realistic but that would mean producing returns in excess of historical averages. It's much better to work to a conservative figure in my opinon.
When calculated as a percentage of net income, this works out to be an implied savings rate of 32% per annum. If we assume that employer superannuation contributions account for 9.5% of that, it still leaves roughly 23% up to you to save. I hope you've been following along with your own figures. How do you compare to this example?
As an illustration, if you can consistently achieve 8% returns on your savings, you would only need to save $14,400 per year (18% of net salary per annum) to achieve your target. While this savings rate might seem more attractive, it's important to be realistic around what is an achievable return.
How realistic is all this?
Saving 20-30% of your net income may seem like a daunting prospect at first, but let's look a little more closely.
In our example, with $80,000 of net income and living expenses of $60,000 leaves a surplus of $20,000 which could be saved. When combined with mandatory superannuation contributions this would be more than enough to provide for a comfortable retirement.
Particularly for young people in stable employment for their entire career, a comfortable, self-funded retirement is not only a possibility but an achievable reality. But as you can see, superannuation by itself will not be sufficient and additional savings and investments will be needed. This is where many people fall short in their planning.
The method shown above is a back of the envelope calculation based on a number of assumptions. You should not take the above as personal financial advice or use this as the sole basis of your retirement planning. Always seek professional advice based on your specific circumstances. If you don't know who to speak with, please feel free to contact me using the details below.