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Everyone needs a financial (including retirement) plan.
It’s very easy to put retirement planning into the too-hard basket, particularly if you are under 40. But these years are when you can make the maximum benefit to your outcome with minimal effort. Due to the amount of time available for compounding of returns, total returns are higher the longer you invest.
It means investing a small amount regularly from a young age can make a surprising difference to the outcome over the long term.
The compounding really starts to take off after around 30 years, but most people don’t even think about retirement planning at that stage.
Most of us, however, don’t want to defer gratification forever.
There needs to be a balance between saving and investing and enjoying the experiences your cash can pay for now. A danger in becoming too extreme in frugality is missing out on the important stuff, and delaying life! It is a fine balance, and very individual.
Would you like to know exactly how much you need to invest to meet your financial goals? If you know how much you need to invest, you know how much you can really afford to spend. This allows savers to enjoy more experiences along the way.
In your twenties, there are a million fun things to spend cash on. Hundreds of dollars can disappear on a great night out. The physical and financial hangover is never as much fun! These are also great years to explore the world with lots of travel.
I implore you not to miss out on these experiences. But right now, we’re pretty limited in our ability to explore. Make sure you are saving or investing the extra cash. Perhaps you could save some for the ultimate trip once travel is a realistic option again, and invest some? You don’t need to have a lot of cash, you can start micro-investing with $5!
Priorities tend to change for many when they start a family. There are only a finite number of years when the kids are little for you to enjoy.
It’s important to fit in all your “bucket list with kids” items in that period before the opportunity is gone.
Those that have the forethought to get their finances into good shape as much as possible before having kids will be glad of a little less pressure. Sleepless nights, tantrums and balancing home and work life are plenty to keep your mind busy without the very common issue of financial pressure.
Your 30s also tend to be the most financially stretched years. Most will have to practice patience and self-forgiveness as their financial picture can get very tight. Saving for retirement can seem an unrealistic thought! Particularly for big-city folk, large mortgages can keep them very cash strapped for many years. Think very carefully before you commit yourself to becoming house poor for the next decade! Over committing to a huge mortgage limits your ability to save for other financial goals, take overseas trips and take time off work when it is needed.
Again, even saving and investing a token amount regularly provides lots of value. Prioritise an emergency fund, then work out your financial plan. Don’t be discouraged if getting on track for your goals is not yet possible, just do what you can to move in the right direction. Things get easier and opportunities will arise to increase your investments.
Salary sacrificing and optimising concessional super contributions offers you, if not a free lunch, a heavily discounted one. Your investments via these vehicles are boosted by tax savings, making out of pocket costs far less onerous.
Hopefully, your 40s will start to get a bit easier. Having recently crossed this dubious achievement, I feel I feel “over the hill” financially speaking.
Money seemed an uphill struggle for many years. The first few years of a mortgage are the toughest, parental leave meant a massive drop in income and childcare and kindergarten was expensive. During these years, our household focussed on maximising any superannuation tax benefits and paying down the mortgage as fast as we could. The principle owed inched down painfully for the first 10 years.
Things got a lot easier after that. Part of that was a step up in income. The kids starting school and reducing mortgage interest have helped to accelerate progress.
The past 4 years since returning to work have involved paying down the mortgage aggressively, purchasing two investment properties and starting regular investing into index fund ETFs. Our super balances are also starting to compound, growing more in a year than we contribute.
When the financial stresses start to ease make sure you notice and use the opportunity to increase your investments to get on track with your goals.
How Much Super is Enough?
AFSA’s Definition of a Comfortable Retirement
AFSA assure us a “comfortable retirement” will cost around $44,818 for a single person, or $63,352 for a couple as long as they own their own home. There is some description of the lifestyle these retirees could afford, including a visit to the local RSL, a domestic flight per year and flying internationally every 7 years.
Many high-income professionals would have become accustomed to a far higher cost of living, with upgraded spending in all categories.
The issue with this is that we tend to lose the skills of managing on a low budget. Once luxury purchases ($20 bottle of wine) are now considered essential. The thought of swapping back to the cask wine of your 20’s is usually incomprehensible. The wine alone may not be a big deal, but upgrading every area of a spending really makes a big difference to cost of living.
If you are in your 20s, so far from retirement it’s impossible to anticipate your required spending, I think AFSA’s “Comfortable retirement” figures are a reasonable starting point. Just remember to reassess every 5 -10 years.
For those in their 30s, 40s and beyond I think starting with your current spending is the best. Then you can make an educated guess, based on expenses that will no longer apply after retirement (mortgage repayments, kids school fees, professional expenses). Remember to add back in additional expenses in retirement (more travel, health care).
Again, don’t worry about it being accurate. More exact numbers will only be realistic in the last few years before retirement. A rough number will get you most of the way there.
Comparing Your Super Balance with Others your Age
Unless you are on an average income, I think comparing your super balance with the average balance at your age is nothing more than a feel-good exercise. The average balance is $417,900 for the top age bracket, male 65-74 years.
If you have earned an above-average income, you should be well above average by your 40s. If you are in your 20s with a delayed start to the workforce, the average may be useful in motivating you to get caught up asap.
Most people currently rely at least partially on the aged pension. High-income earners should consider the aged pension only as insurance if all else goes wrong.
Aiming for the Super Balance Transfer Cap
Another strategy is aiming for the “super balance transfer cap”. This is somewhat arbitrary and unrealistic for those without a high income. But removes a lot of complications and is also a good starting point.
The super cap is the maximum you are allowed in superannuation that can be transferred to a pension account and received as a tax-free income. This year’s cap is $1.7 million per person. If you have over $1.7 million in your super account, this means you will continue to pay 15% tax on the excess that has to be kept in accumulation phase.
We are all different, but for us $1.7M for one or $3.4M would be excessive for our spending. It is worth being aware that if you might hit the super cap, you should consider sharing your super with your partner (assuming they have a lower balance). Individuals with large amounts of super will be an easy target for future governments looking for new sources of tax revenue. I think it makes a lot of sense to have your super balance (and assets in general) as evenly spread between spouses as possible.
The super cap changes with indexation and is not immune to being fiddled with by future governments.
What is a Super Calculator
If you have ever opened the correspondence from your superannuation fund you will have come across a super calculator. Most of the super funds have calculators on their sites and will often send an individualised projection according to your super balance.
I entered a theoretical situation into several super calculators online to find out how similar they were in their projections. The situation is a 30-year-old male, earning $150,000 receiving 10% employer super contributions only with a balance of $50,000.
There is a $227, 000 difference between the highest and lowest projection. Retirement income projections varied from $29,176 to $52,119. There is so much variation it makes the projections almost meaningless.
Issues with Super Calculators
The issue with super calculators, and investment projections, is there are multiple variables you need to make assumptions on. The super calculators generally make these assumptions, although the better ones allow you to change these. Variables include:
Rate of Return
This is probably the biggest factor of all. Whether the stock market will return 5% or 10% over the next 10 years makes a huge difference to your retirement balance. No one can predict what future returns will be. There were widespread expert predictions that returns would be lower than previously when I started investing in 2017. I’m glad I ignored them.
There is also a huge variation in the asset allocation of super products. Whether you are 25% stocks or 25% cash is going to make a big difference to your long term returns.
Most super calculators assume a generic rate of return. Each one I looked at made different assumptions.
Long-term historic returns are the best we have to go on. Have a look at your super product. Make sure it is appropriate for your situation. Use the targeted return for your fund in super calculators.
Super fees will also make a difference over the long term. Fees are sometimes ignored by calculators, at other times a generic fee estimate is made.
Fees are the only guarantee with investing. Minimising them makes a guaranteed improvement in returns. Check your super website and see what fees you are paying. Check they are within the lower half of super products available, and certainly under 1%.
Perhaps you are maxing out your concessional contributions. Kudos! But if you have your life, TPD and income protection insurance premiums coming out of your superannuation, not all your contributions are staying invested. Watch out for overestimating your super by ignoring insurance premiums.
Again you can easily find out the total premiums paid from your super from the website.
Super withdrawals are generally tax-free if you are retired and over your preservation (mostly 60 now). But if you are over the super cap, or younger than 60, you may have to pay some tax.
Unless you have a particularly unusual situation, I think it is reasonable to assume income will be tax free.
Some super calculators assume a retirement age of 65 or 67. Most will allow you to change your retirement age to 60, but no younger. This makes super calculators of limited utility for early retirees.
Time is the other huge factor in investment returns. If you assume you will work to 67 but actually end up wanting (or needing) to retire at 60 your projections will be meaningless. Best to assume you will be a younger retiree and ensure you are prepared in case of unexpected health or life changes.
Again, assumptions need to be made about inflation. The long term target of ~2.5% is often used. I don’t think this can be predicted with accuracy, but as long as you review your expected retirement spending every few years, along with assets accumulated, you can adjust for unexpectedly high or low inflation over time.
Change in Salary over Time
Super calculators assume you will earn your current income for the rest of your career. This is wildly inaccurate for young professionals just starting out, who may be expecting large jumps in income.
Use this to comfort yourself if (when?) you find it is impossible to currently get on track to your goals. Unless you’re close to your expected top salary, there is no need to panic. Just keep swimming in the right direction.
None of the super calculators I have tried out allow for multiple changes in salary over the years. Professional projection software I suspect could do this. But there are so many assumptions, I’m not sure its worth the expense. If your assumptions are out, the detailed and “accurate” projections will be wrong anyway. And it seems unlikely you will make all the assumptions needed accurately.
If you’re anything like me, you will find this annoying! Uncertainty is unfortunately unavoidable.
Some of the super calculators allow you to include career breaks for parental leave or extended travel, fellowships etc.
Super calculators will make an assumption about how much of your balance you will withdraw each year, and give you an estimate of when you will run out of superannuation.
There is huge controversy around the acceptable withdrawal rate, and this will likely change closer to the time depending on your health, balance and risk tolerances.
A rough rule of thumb is that a 4% withdrawal rate is very likely to last 30 years in retirement.
Information Required to Use a Super Calculator
Ideally you want to use as much information as you can to get your super projection as close as possible. This free calculator has a lot of detail, and lets you play around with the variables without starting the entire process from the start.
Super calculators can give you an idea of how much extra you should invest to reach your retirement goals. They are limited by the huge number of assumptions that need to be made. The projections get more accurate the closer you are to retirement age. I still think they have a benefit in the younger years, to get you moving roughly in the right direction. It’s important not to panic when you realise you cannot currently get on track, just keep swimming in the right direction.
Aussie Doc Freedom is not a financial adviser and does not offer any advice. Information on this website is purely a description of my experiences and learning. Please check with your independent financial adviser or accountant before making any changes.