Retirement – how much is enough?

By July 7, 2019 July 22nd, 2019 No Comments

How much do you need for your retirement? When developing a financial plan, goal setting is critical. After all, if you don’t know where you’re going, it’s hard to call anything you do a plan! That’s why we put so much focus on getting clear with clients what it is they want out of life – and often, when we get right down to it, those goals can be achieved a lot easier than people sometimes think.

But how do you define a goal? For us, a goal needs to be SMART – Specific, Measurable, Achievable, Relevant, and Time-bound. Some of these are easy; it’s often straightforward to decide when you want to do something, for example. The age of eligibility for NZ Superannuation is currently 65, simple math will tell you how many years away that is for you. But how do you decide some of the other measures? Being specific – how do you work out how much you’ll need for retirement?

Consider what your lifestyle is likely to look like

Your key consideration when thinking about retirement planning is what you’d like your lifestyle to be. This is a deeply personal and widely variable choice. Some people look forward to yearly travel; some people prefer Dom to Bolly; others decide that retirement is the perfect time to unleash their inner Steve McQueen. And others are just as happy with a quiet, simple life enjoying spending their time with friends and family. It’s useful to have a (honest!) view of where you want to be before you start planning.

Where you live has a significant bearing too. Metro (particularly Auckland, Wellington, and Queenstown) cost of living and lifestyle tends to be significantly more expensive than, say, Kaiwaka.

To help give some guidelines on likely spending in retirement, we typically turn to evidence-based research.

Research-based benchmarking

We like the work that Massey University has done, in conjunction with Westpac, on the cost of retirement in New Zealand. We like to use this as a starting point for estimating retirement costs in today’s dollar. For example, the 2018 report (pdf) states that a couple on a “no frills” budget, living provincially, should plan to spend around $630 per week – assuming they’re living in their own mortgage-free home.

Using this as a baseline, we typically adjust up or down based on potential lifestyle factors. For example, the Massey expenditure guidelines don’t factor in anything for post-retirement travel spending. If a client is a big traveller, we’ll most likely build an additional allowance in for this, particularly for larger one-off travel goals. Another example would be housing costs; the Massey numbers include an allowance for rates and body corporate fees, but if we know these are likely to be significantly higher, we’ll adjust accordingly.

The final piece of the puzzle is life expectancy. How long are you likely to live? Typically these days we’re assuming retirement lasts into the 90s. And there are plenty of suggestions that the average first-world baby born today will live past the age of 100.

Work the numbers

Once you’ve got a handle on your estimated cash needs and how long you think you might need to fund your retirement, we can start to work backwards to a (S)pecific goal. We do this by calculating the present value of your future cashflow. Here’s how it works:

We sum up your likely income and expenses. If you’re a couple estimating $1,000 a week of spending per year, that’s $52,00 of cash that will be heading out the door. But this will be offset by income – in New Zealand, if both of you are eligible and tax code M, you’ll be paid $32,892.08 in todays dollars a year after tax, through the NZ Superannuation scheme. In the case of our hypothetical couple spending $1,000 per week, they’ll only need to fund an additional $19,107.92 per year, or $367.46 per week, from their own savings.

In addition to NZ Superannuation, the reality is that many people continue to work past age 65. There is a high correlation between productive work and a happier, healthier retirement, so it’ll help you live longer too. It may only be for a few years, but 1 or 2 days a fortnight of work later in life can make a material difference to your health, wellbeing – and your bank account too.

We work out what your annual spend is as a lump sum. Assume our couple has decided that they need to fund $19,107.92 of their annual retirement spend themselves, and they’re expecting to need to do so for another 20 years. $19,107.92 per year for 20 years = $382,158.4. But we need to work out how much you’ll need on day one once we factor in inflation and your investment return. If we assume inflation of 2% p.a., and a post-tax, post-fee return of 3.5%, we’re taking a net return of 1.5% p.a. Discount the lump sum by this rate of return for 20 years, and we find you’ll only need $328,056 on day one. The remaining $54,101 will come from investment return.

However, we need to understand the impact of inflation between now and the date of your retirement. To do this, we calculate the future value of that sum – $328,056 – based on an estimated inflation rate. This will give us a nominal target sum, which, if we assume 2% p.a. again, and 10 years til your retirement date, is $399,899.62. Which is a good sized number – but a fair way off the $1M minimum that some people talk about!

Building the plan

From here – using your (S)pecific goal – you can start to work out a plan to get there. We’ll talk a little more about the planning process next time, and about building a strategy to reach your goals – in particular in todays low-inflation, low-interest environment. Lower-risk, higher-yield investments are at sky-high prices these days, and for many people, putting cash in the bank or low-return term deposits might mean they’re going backwards, in real terms – we’ll have a look at ways that people can prepare for this and make good investment choices earlier. Until then – happy planning!


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