Wednesday, 15 August 2012

How much superannua​tion will I need when I retire?

For all of us who live and work in Australia, the superannuation system provides a thought free way of providing for our retirement.  Our employers are required to contribute a certain amount of our income (currently 9%, moving to 12%) to a retirement plan that will hopefully pay for our nest egg.
The problem many of us have is that we do not know
  1. Whether we will have enough when we retire to keep us going right through retirement
  2. How much we need to save outside of super
The key is to work back to front
Instead of working from how much you contribute today, expected rates of return and expected wage increases - all of which are VERY assumption dependent, the key is to work backwards from what you want when you retire.  This is totally subjective and there is no right, wrong or unrealistic answer.  If you want to live on a million dollars in today's money when you retire then you can work out what you need to do to get there.
  1. Work out how much money you want per year in retirement
    • The fact is that you don't actually need that much per year in retirement. 
      • You do not have the same obligations as you do now - your house is paid off, you have no mortgage, the children have moved out
      • You are not limited to travelling and holidaying during the peak seasons - holidays are cheaper
      • Chances are that you are not as active as you are now so you will not be able to do the types of activities that you do now
    • Try and think about what you would spend you retirement doing and how much this would cost and then add a bit extra - it is always good to have a bit of a buffer
    • For the purposes of this example I am going to say that I will need $100,000 per annum in retirement (in today's dollars)
  2. Estimate what age you are going to retire at
    • I keep seeing people saying they want to retire at 40.  Honestly I do not know what I would do if I retired that early...I enjoy working and what I do so don't know what I would do by retiring that early
    • For the purposes of this example I am going to say I retire at 60
  3. Estimate how long you will need the money for
    • This is quite subjective but I'm going to say I will need it until I'm 85.  Chances are I will not last that long but we can always home
    • In the example that is 25 years of income required
  4. This will give you your estimated required nest egg
    • In today's dollars that's 25 years of $100,000 which is $2,500,000
    • Calculate this at the point of your retirement (i.e. inflation adjust it until you're retirement age).  For me that is 36 years away.  I'm going to assume an inflation rate of 2.5% p.a.
    • This yields a future value of $6,081,338
Don't be scared by the big numbers.  Keep going through the process
The future value of 6 million dollars looks HUGE.  But don't forget that you are just working out how to achieve it.  You are never going to get anywhere by paring back your expectations.
The next step is to see how much you will have in superannuation assuming you do nothing
Because superannuation is a government requirement of your employer - this is a savings number that you have no choice about.  Thus it should be the first part of your calculation in how to get to your goal.  Follow the steps below using your own numbers.
  1. Take the super you already have as a starting point
    • Most of us already have a super balance so use this as your starting point
    • In my example I will sue $28,000 as the starting point
  2. Work out your total wage and the amount of superannuation that comes out of it
    • For the purposes of this example I'm going to say the wage is $150,000
    • Superannuation is currently 9% p.a.
    • Thus this year I will get a superannuation contribution of 150000*0.09 = $13,500
  3. Work out the amount your wage (and thus super) is expected to increase each year
    • Most of us get at least inflation increases to our wage each year (i.e. 2.5%).  If you are in an industry which typically gets more than this then put this down
    • I am going to use 4%
  4. Work out the expected return on your superannuation
    • If you are in the high growth option in your superannuation plan then use a return figure of about 8%
    • If you are in the cash only bucket then use more like 4% and if you are in between then use a number in between
    • I am quite risk neutral so I will use 7.5% p.a.
  5. Don't forget taxes
    • Do not forget that earnings within superannuation are taxed at 15% p.a. so do not forget to include this in your calculations
  6. Set up a spreadsheet to do your calculations (this should be fairly easy but if you want me to upload one just comment below)
    • For the parameters listed above I get an ending value of $2,944,220

The extra amount is the amount you need to save / invest / contribute over and above your super amount
In my example the difference is $3,137,118 which is the amount I will need to come up with over my investment life.  This again seems like a large number but if you start to break it down over a long period of time (in my example 26 years) it is much easier.  For example the following ways can get you to your goal
  • An extra $25,000 per year (or ~$2,000 per month) in superannuation will get you to your target easily.  This may seem like a lot of money but if you look at my savings plan I am doing more than that consistently every month
  • If you vary some of your assumptions it becomes easier to get there.  E.g. if you include 12% contributions from 2015 you only need to contribute $19,000 per year (~$1,500 per month) to get to your desired target
  • Note these additional amounts are not inflation adjusted.  I.e. even though your wage is going up every year the amount you contribute is staying constant.  If you do want to inflation adjust how much you contribute your contributions are even less
Your goal is achievable - you just need to plan early and work out what you need to do to get where you want to go
All goals are achievable - you just need to work out early what your plan of attack is and then let the power of compounding returns work over a long period of time.  The fact is that you are at a major advantage if you are doing this planning process in your mid 20s compared to your late 40s so start early and retirement can be easy.

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