Wednesday 28 February 2018
A comfortable retirement: what and how achievable is it?
A couple will need $60,457 per annum to fund a comfortable lifestyle in retirement, assuming they own their own home and have no debt. A single person would need $44,011 per year. These are the numbers the Association of Superannuation Funds of Australia (ASFA) released for the September 2017 quarter1 as part of its ongoing ASFA Retirement Standard benchmark monitoring. Refer to the ASFA Retirement Standard for information about the budget breakdowns that support these numbers.
In a media release2 dated 4 December 2017, ASFA indicated that a couple needs approximately $640,000 to fund a comfortable retirement, and $545,000 for a single person.
So how can the income required for a comfortable retirement be funded, and how much should be put aside each year prior to retirement to accumulate the funds required to fund a comfortable retirement? The following analysis is intended as a guide for financial services professionals to help their clients set attainable retirement goals.
Funding a comfortable retirement
ASFA calculates that $640,000 is sufficient to fund a comfortable retirement lifestyle. Their calculations assume a couple owns their own home and will receive Government age pension support when they retire.
Macquarie Technical Services has modelled the retirement income for a couple in this situation based on the current income tax and social security rates and thresholds. The latest rates and thresholds can be accessed in Macquarie Technical Services' Little Black Book.
It is assumed that $640,000 is held in a superannuation fund and used to commence an account-based pension. Note however that if the funds were held outside super in joint names, there wouldn't be any significant change in the outcome, as the couple are unlikely to pay any income tax on the portfolio returns, based on our return assumptions (see Appendix) and the current income tax law. Nor would their social security entitlements change. It is also assumed that the couple's home contents and car are valued at $25,000.
Chart 1 below shows the projected position of this couple from age 67 to age 106. The couple draw only what they need from their superannuation account-based pension to top up to their age pension income to the required level of total income for a comfortable retirement. The level of income needed, based on ASFA's model, decreases from approximately $60,000 per year prior to age 85, to approximately $55,000 per year - this reflects a relatively less active lifestyle as age increases.
Although their age pension entitlement is just $12,000 (approx.) per annum in the first year, that entitlement grows over time as their assets reduce - the couple become entitled to the full age pension from age 91.
The analysis indicates that the income needed could be maintained until age 99, well beyond the life expectancy of a 67 year old female (age 87.3 years) or male (age 84.6 years). The couple's account-based pension would run out by age 101 - refer also to Chart 2 below.
This outcome is sensitive to the earnings rate assumption (6.7 per cent per annum). ASFA's assumption of 7.0 per cent per annum increases the age to which the income level can be maintained by a year, to age 100.
Other sensitive assumptions include the amount of non-financial assets ($25,000) and financial assets, for example cash holdings ($nil). These assumptions may affect the couple's age pension entitlement, hence the amount of pension payments that need to be drawn from the account-based pension. But note that financial assets may have a net positive impact due to the additional income produced.
Our modelling supports ASFA's proposition that approximately $640,000 is an appropriate level of funds for a couple to target for a comfortable retirement, if we accept that approximately $60,000 per annum is needed to achieve that.
Saving for a comfortable retirement
Taking ASFA's numbers ($640,000 for a couple, $545,000 for singles) as appropriate funding targets, then a natural subsequent question is:
How much should be saved each year to reach the relevant funding target?
Our modelling has, for simplicity, focused on a single person reaching the $545,000 (in today's dollars) funding goal by age 67, which is the Government age pension eligibility age for those born on or after 1 January 1957.
A key feature of retirement funding for Australian employees is the compulsory superannuation contributions employers are required to make on behalf of certain employees - the Superannuation Guarantee (SG) system. As far back as 2007, the coverage of the SG system had reached 94 per cent of all employees,3 a significant increase from the position in 1974 when only 32 per cent of employees had superannuation.4 So today most employees have some level of superannuation contributions being made on their behalf.
The current SG rate is 9.5 per cent of an employee's Ordinary Time Earnings (OTE). Generally, OTE relates to ordinary hours (excluding overtime), and includes commissions, shift loadings and certain allowances. The 9.5 per cent rate will increase by 0.5 per cent per annum from 2021 to 2025, ultimately to 12 per cent.
The Average Weekly Ordinary Time Earnings (AWOTE) for the October 2017 quarter was $1,567.90,5 or $81,755 per year. In our modelling, again for simplicity, we used $80,000 per year. Employees with this amount of income will have SG contributions of 9.5 per cent ($7,600 per year, paid quarterly) paid by their employer to a superannuation fund. These contributions are generally taxed at 15 per cent, so $6,460 is available to be invested by the superannuation fund each year.
Our modelling covers a range of income levels, from 50 per cent of the rounded AWOTE number ($40,000) to 150 per cent ($120,000). It also covers a range of ages, from 20 to 60, and a range of existing superannuation balances, from $nil to $200,000.
Table 1: future SG contributions accrual to age 67
|current age||$40,000 OTE||$80,000 OTE||$120,000 OTE|
Table 1 above shows that a 30 year old with earnings of $80,000 per year may accrue $536,000 in superannuation between now and retirement at age 67 from their future SG contributions alone, assuming no breaks in their employment. This amount is only slightly short of the comfortable retirement target of $545,000.
Table 2 shows the amount the same individual in Table 1 would need to contribute to superannuation on an after-tax basis (non-concessional contributions) to reach the funding target of $545,000, assuming they have nothing in super currently. The 30 year old individual considered above would need to contribute only $124 per annum
Table 2: After-tax super contributions per annum to reach retirement goal at age 67
|current age||$40,000 OTE||$80,000 OTE||$120,000 OTE|
These numbers are represented in Chart 3 below.
Many employees will have existing superannuation accumulated from employer SG contributions and/or additional employer or personal contributions. Charts 4 and 5 below show the reduced funding level required to reach the retirement goal based on an existing superannuation balance of $100,000 and $200,000.
Chart 4 shows that an individual who is aged 40 with $100,000 currently in superannuation, earning the Average Weekly Ordinary Time Earnings, will achieve the comfortable retirement funding target without making any additional superannuation contributions over their employer's compulsory SG payments. If the same individual was earning $40,000 per year, they would need to contribute an additional $3,226 per year.
These charts show that many Australians may be in a position to achieve a comfortable retirement, based on ASFA's definition and assumptions. The Australian Superannuation Guarantee system is a significant part of achieving this outcome, which relies on the currently legislated increases in the SG rate to 12 per cent.
Since its humble beginnings in 1992, when the SG rate was just 3 per cent and covered only 72 per cent of the workforce, the SG system has matured into a solid foundation for many Australians' retirement funding aspirations.
Depending on income levels over their working life, those entering the workforce today may achieve a comfortable retirement via their SG contributions alone. Those employees who weren't lucky enough to have SG at 9.5 per cent or higher throughout their working life nonetheless generally have a solid base upon which to further build via voluntary after-tax non-concessional contributions, salary sacrifice employer contributions, or (since 1 July 2017) personal deductible contributions up to $25,000 (including their SG contributions).
Appendix - Projection Rate Assumptions
The after-fees pre-tax projection rate of 6.7 per cent per annum used in this article is based on the asset class weightings, long term income and capital growth projection rates and other assumptions in the table below.
These rates aren't guaranteed, are provided as an illustration only, and may vary from actual results. The projection rates aren't intended to be and shouldn't be relied on when making a decision about a particular financial product. Before making any financial decisions you should seek personal financial advice from an Australian Financial Service licensee.
|Asset Allocation||Capital Growth||Income||Franking Percentage||Tax free proportion||Tax deferred proportion|
|Australian Fixed Interest||20%||-||6.5%||-||-||-|
|Overseas Fixed Interest||10%||-||6.0%||-||-||-|
|Fees per annum||1.5%|
|Holding Period in years||5.0|
|CPI rate per annum||2.5%|
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