Start planning for your retirement

HOW much money will I need in retirement? This is one of the key questions people should ask as they save for a comfortable retirement, but also one of the hardest to answer.

A handy rule of thumb favoured by many financial advisers is to assume people will need between 60 and 75 per cent of their final pre-retirement income.

The logic behind this is fairly straightforward, according to RetireInvest Subiaco managing proprietor Scott Lee.

The starting point is that our spending patterns generally correspond to our income levels. If we earn more income, we tend to spend more. And, once we get used to a certain level of spending, it is hard to break the habit.

Mr Lee said people needed to recognise the changed tax situation pre and post retirement. When people are still working, they typically pay between 25 and 30 per cent of their salary as income tax.

Once they retire, there is scope to minimise tax through income splitting with a spouse, use of tax-effective retirement income products like allocated pensions, and greater reliance on dividend income, which attracts little if any tax as a result of franking credits.

In addition, there are certain work expenses, such as buying expensive suits or other work-related clothing, that cease upon retirement.

Adjusting for these factors, Mr Lee usually finds that people can maintain their living standards on 60-75 per cent of pre-retirement income. Interestingly, this could be 75 per cent in the first few years of retirement then drift down to 60 per cent.

From this simple starting point, planning for retirement can get a lot more complicated. It is not just the financial calculations.

Family and lifestyle issues also have a big impact.

For instance, will the family be debt free or will you still be paying off your house? And would you be prepared to sell the family home and move into a smaller residence to free up some capital?

Will your children be financially independent, or will they be studying and living at home?

Do you plan expensive inter-national holidays, or would you prefer fishing holidays at a caravan park?

Mr Lee said planning for retirement also could be affected by an individual’s values. For instance, many people pride themselves on being financially self-reliant and would prefer not to apply for a government pension.

Others would quite happily structure their financial affairs to maximise their pension entitle-ment.

However, with an ageing society, governments will be under increased pressure to restrict pension entitlements to those truly in need, or to reduce the real value of the aged pension.

Last, but not least, people need to recognise that their retirement savings need to last them for a long time. At the age of 60, males have a life expectancy of 20 years and females 24 years.

So if you plan to retire at age 60 and want an annual income of $30,000 (increased each year to keep pace with inflation) how much would you need?

RetireInvest has calculated that you would need a total of $525,000 earning 7.5 per cent per annum to generate this level of after-tax income.

How much would you have to save each year to reach this target? If you are aged 40 and have $50,000 already, you would need to save $13,853 each year until retirement.

If you are aged 50 and still have only $50,000, you would need to save $40,018 each year.

This indicates that the earlier you start saving, the easier it becomes.