Menu

Retirement: Today’s dollars, and why $1 million can’t last forever

Note: This article is a supporting article to the two-part series, ‘Crunching the numbers: a $1 million retirement (7% and 5% returns)’ and ‘Crunching the numbers: a $1.6 million retirement’ (links for these articles are set out at the end of the article).

Before I receive dozens of emails stating that $1 million can indeed last forever, let me start with the following statement: If you live off only the earnings from your invested capital then your capital can indeed last ‘forever’. The dilemma facing all investors and retirees is balancing the desired lifestyle (and maintaining that lifestyle over 20 to 30 years) with protecting capital, and potentially leaving some wealth behind for your children or other dependants.

Important: Further, if you choose to use the superannuation system for your retirement plans, then you must withdraw a certain percentage of your pension account each year to receive concessional tax treatment on your super pension account’s earnings.

This article explains the concept of ‘today’s dollars’, and highlights why allowing for inflation when planning for retirement ensures that you protect your desired standard of living when you retire.

Note: Both political parties (ALP and the Liberals/Nationals) intend to introduce a cap-of-sorts on the amount of tax-exempt pension earnings that can be generated from a super pension account. From July 2017, depending on which party wins the 2016 Federal Election, if you have substantial assets in pension phase, you may have to pay 15% tax on some of your pension earnings. For more information on this proposed change, see SuperGuide article 2016 Federal Election update: What superannuation and retirement policies can you expect? and more specifically, see SuperGuide articles Liberals to impose $1.6 million cap on pension start balances and ALP to tax pension earnings above $75,000 a year, if wins election.

What questions do you need to answer to help create a dream retirement?

Some of the most important questions you need to ask when planning for your retirement are:

In May 2016, we updated and revamped two articles on the SuperGuide website outlining what $1 million can deliver you in retirement, and what $1.6 million can provide in retirement (the $1.6 million retirement article used to be a $2 million retirement article, but due to the Coalition’s proposed cap of $1.6 million on starting retirement balances, we revised the article to reflect the proposed cap).

The two articles are very popular articles on the SuperGuide website, and consequently I have received many emails challenging the fact that $1 million could ever run out when earning 7% after fees in a tax-free environment, and when receiving a certain level of income.

The confusion seems to be around withdrawing a flat level of income that doesn’t change for a 20-year or 30-year retirement, or withdrawing an income that increases in line with the cost of living (inflation). We have also updated the $1 million and $1.6 million articles with an explanation of today’s dollars (the links for the two updated feature articles are at the end of this article).

In collating the figures for the two features, I relied upon the Australian Securities & Investments Commission’s MoneySmart retirement planner calculator. For an official response on the issue of whether a retiree could run out of money, I previously forwarded a selection of reader questions (just the questions not the actual emails) to the creators of the MoneySmart calculator. They provided explanations for why a $1 million retirement can still mean that you eat into your capital and eventually run out of savings.

Three popular questions from readers

Three questions from readers, and ASIC’s earlier response to those questions, are set out below:

1. Reader question: Can you please explain to me how the million dollar super ever runs out? My thoughts are, if you have a million dollars in super and it returns 7% then you acquire $70,000 a year. This is just spending what your fund earns, not the one million dollars as a principal sum, so why does it ever run out?

ASIC’s response: The MoneySmart Retirement Planner works in “today’s dollars”. So if we assume an inflation rate of 3%, the calculator also increases your drawdowns by 3% each year in order to maintain a similar lifestyle. This means that a $70,000 withdrawal per year would partially dip into your capital after year 1. Or, expressed another way, a notional return of 7% is equal to a real return (after inflation) of 4%. If you only withdrew 4%, it would last forever.

Note: You can see the difference between today’s dollars and tomorrow’s dollars in the SuperGuide table appearing later in the article.

2. Reader question: I just don’t get it. If I have $1.6 mil @ 7%, I generate $112,000 pa so how can my super run out at 87 or 100 if I only withdraw $100,000 pa? Will my super not keep growing? Or is it to do with the aged-based minimum withdrawal increases?

ASIC’s response: If we assume an inflation rate of 3% we also assume that you will increase your drawdowns by 3% each year in order to maintain a similar lifestyle. In effect, your real returns are only 4% each year. This means that you would start to dip into your capital after year 1. You earn 4% in real terms [Trish’s comment: but the amount being withdrawn is more than 4% in real terms each year, which explains why your capital base falls].

For example, if you start at age 65 with $1.6 million, you can draw $83,895 income per year (indexed each year by 3%, and assuming an investment return of 7%) and your funds are estimated to last until age 100.

3. Reader question: I wanted to ask about your statement in this paper [in the introduction of $1 million retirement article] to the effect that a “lump sum of $400,000* can deliver a couple nearly $59,000* (indexed) a year in retirement (which includes the couple’s Age Pension entitlements) until the age of 87?. Using an Age Pension calculator, I get a figure of approx $23,000* per annum from the Age Pension (for a couple). That leaves about $36,000 per annum to make up. Trouble is, according to my calculations anyway, with a super balance of only $400,000, I can’t see a way to generate $36,000 for 22 years, even if invested at 7%, especially if we insist on indexing it at 3%. Have I missed something?”

ASIC’s response: The full Age Pension for a couple is roughly $34,252* a year, while for a single person it is just under $23,000* a year. On an account balance of $400,000*, the MoneySmart Retirement Planner estimates the income (Age Pension + super) to be just over $59,000*, which includes a substantial part Age Pension, or full Age Pension for many of those retirement years.

Trish’s note*: These figures are adjusted by Trish Power to allow for Age Pension increases incorporated into MoneySmart Retirement Planner since the article was first published. The lump sum of $400,000, along with a substantial part Age Pension, delivers just over $59,000 a year for a couple, assuming savings are invested in assets that return 7%, and annual income is indexed at 3%, and including Age Pension entitlements. SuperGuide’s calculations also assume no lump sum expenditure in the first year from the account balance, and that super savings run out at the end of the person’s 87th year.

Indexing your income protects your lifestyle

I also want to explain the how inflation (cost of living) and indexation (the modelling tool to combat inflation) translates into the concepts of ‘today’s dollars’ and ‘tomorrow’s dollars’.

The term, ‘today’s dollars’, is confusing especially when you’re looking up to 20 or 30 years into the future. Translating your tomorrow dollars into today’s dollars enables you to plan for the type of lifestyle that you want in retirement. If you use tomorrow dollars, they will be relatively meaningless when looking many years ahead.

Using an example, say you want to live on $50,000 a year in retirement and you plan to retire today. When you think of $50,000 a year I assume you’re imagining what $50,000 can buy you today and that’s the lifestyle you’re aspiring to. Cost of living increases are a fact of life nowadays so if you want to maintain the lifestyle that you can expect on $50,000 in today’s dollars, then you will need to increase your annual retirement income each year to maintain your lifestyle of today. If prices increase by 10% over the next three years, then in three years’ time you will need to be taking a retirement income of $55,000 a year, to match your lifestyle on $50,000 a year in today’s dollars. If prices increase by 20% over the next six years, then in six years’ time, then you will need to be taking a retirement income of $60,000 to match your current lifestyle on $50,000 a year.

The ASIC MoneySmart calculators automatically build the increase in payments into the calculations, although I use 3% cost of living adjustment in my examples, rather than the default 4.0%. For example, if I have quoted a lump sum amount that will deliver $59,000 a year for 22 years, then that lump sum takes into account increasing the annual income by 3% a year, even though we quote $59,000 in today’s dollars.

The $1 million and $1.6 million features referred to in this article (see links at the end of this article) allow for 3% inflation when working out annual incomes, so the figures in these features automatically allow for the annual adjustment in retirement incomes.

Comparing today’s dollars with tomorrow’s dollars

For those readers who are still sceptical about how $1 million, or even $1.6 million, can run out at certain levels of income, here’s another scenario.

For example, Beverley, age 65, retires today with $1 million. If she wants her money to last until she turns 100, and if she wants to maintain the lifestyle that she enjoys in her first year of retirement, then based on her savings, she can expect an income of $55,750 in the first year, and that income will be indexed each year by 3%, and she will run out of savings at the age of 100 (assuming an investment return of 7% each year).

In today’s dollars, Beverley’s annual retirement income for each year works out to be roughly $55,750 a year in today’s dollars (although significantly more in tomorrow’s dollars, that is, what she will actually receive each year).

Beverley’s friends think that she is being ripped off by these estimates. The friends work out that if you stick $1 million in the bank and in shares within her super fund, and the super fund receives bank interest and dividends and other income, at 7% a year (after fees and taxes), then Beverley’s money should never run out if she only takes out $55,750 a year. In fact, her savings should be growing not diminishing. Earning 7% on $1 million each year works out to be $70,000, and this figure should grow as she accumulates more retained earnings. What’s the story?

The ‘story’ is reasonably straightforward: If Beverley wants her lifestyle to be maintained, then taking out only $55,750 in 10 or 20 years’ time will not deliver her the lifestyle she wants. If Beverley withdraws $55,750 in absolute terms, that is, in tomorrow’s dollars, each year, then she will certainly retain her capital for longer, but her standard of living will dramatically decline in real terms, that is, in today’s dollars.

In 20 years’ time, Beverley’s lifestyle will have nearly halved in real terms, if she continues to take the same dollar amount that she first withdrew 20 years earlier.

I have used the ordinary calculator on my iphone to calculate the income Beverley needs to withdraw from your super pension each year in tomorrow’s dollars, to maintain today’s lifestyle of $55,750 (see table below), assuming 3% indexation/inflation. You can also do these calculations using an online calculator, such as ASIC’s account-based pension calculator (refer to Pension1 tab). For those wanting to manually calculate their future payments, simply multiplying $55,750 (or your expected income) by 1.03%, and then multiplying that result ($57,423) by 1.03%, and continuing these calculations each year on the revised income in tomorrow’s dollars.

Note: In practical terms, if Beverley accepted that she was willing to have a lower standard of living as she got older, by taking out the same amount every year (without indexation) until age 87, then she could enjoy a higher standard of living in her earlier years (and higher income than $55,750 in tomorrow’s dollars) and cop the fall in lifestyle later.

Beverley’s retirement income when retiring at age 65 with $1 million

Age (receiving retirement income)Tomorrow’s dollars  (actual payments)Today’s dollars (payments in real terms)
65 (retires today)$55,750
66$57,423$55,750
67$59,145$55,750
68$60,920$55,750
69$62,747$55,750
70$64,630$55,750
71$69,154$55,750
72$71,228$55,750
73$73,365$55,750
74$75,566$55,750
75$77,833$55,750
76$80,168$55,750
77$82,573$55,750
78$85,050$55,750
79$87,602$55,750
80$90,230$55,750
81$92,937$55,750
82$95,725$55,750
83$98,597$55,750
84$101,554$55,750
85$104,601$55,750
86$107,739$55,750
87$110,972$55,750

Note: Incomes in tomorrow’s dollars (using 3% indexation).

Crunching the numbers: Retiring on $1 million (or $1.6 million)

Due to popular demand, we have updated our 2-part special on what a $1 million lump sum can deliver you in retirement, and what a $1.6 million lump sum can give you as a single person, or a couple, and whether you retire at 56, or at 61 or 65, 67, or even 70. Click on the article links below:

You may also be interested in an older article from one of our readers explaining how $1 million can indeed last forever. Be sure to check out the comments from other readers – it is a great read (note that we are not accepting any more comments on the guest contributor article):

Comments

  1. Hi Trish,

    Thank you for the article. I understand the impact of inflation in retirement, but I’m still confused with retirement planning 25+ years out. If one wants an after tax income of 100,000(in todays dollars) to age 85, assuming 3% inflation, what do you need to have saved by 65 (2045) with 5 returns thereafter.

    We are actively salary sacrificing hoping to have a high balance at 40 that will enable a transition to part time/less stressful work, allowing compound interest to increase super savings. Problem is, I can’t figure out what the balance should be at 40 if we then only contribute modest sums to super. It seems this goes against advice of some planners who advocate waiting until your mid 50s to contribute maximum super, but we don’t want to be working full time in our 50s/60s. I’m very conservative and figure if we have a house paid off and a high super balance at 40, we should be able to sleep easy at night! Both of our parents are struggling in retirement and we are trying to heed their advise and plan early.

    Thanks,

    Sam

  2. Bert born 1930 says:

    LoL Do you really think an 85 year old will be flying off to Bali every year ? Or renewing their $1500pa gym membersahip ? buying $200 reeboks ?? As you get older your expenses DECREASE. All these $1,000,000 retirements are promoted by greedy interests

  3. This and related articles appear to assume that an annual draw of 4% will continue for life. Of course, to remain compliant, a superannuation fund must distribute a minimum percentage of the account balance each year, which increases over time, from 4% at age 55 to 14% at age 95 and beyond. Surely a much higher starting balance is required to achieve a reasonable income after age 80, when the minimum draw increases to 7%.

    • @ David . Your right the draw downs increase from super as you age that doesn’t mean you have to spend it. The 4% SWR is based on your spending rate. The extra money withdrawn can be reinvested outside super the tax free thresholds are pretty generous at 65 the SAPTO allows 59k tax free for a couple outside of super.

  4. Dear Trish

    Graeme Walker’s comments seem spot on to me, in particular that lifelong needs are unpredictable and the further out we plan, the more uncertain those needs become. That’s why the ASIC calculator builds in an extra bit of ‘inflation’ on top of simple cost of living (CPI).

    Based on my experience in looking after my very elderly parents’ finances, the cost of living can really increase significantly in your 80s and 90s. Medication, more frequent doctor’s visits that cost more if required at home, and possible nursing home fees (including bonds) push up costs in your final years. While most people may not need to go into a nursing home, if you do, then a ‘comfortable’ lifestyle of a quiet residence, a pleasant room of your own, nicer food, onsite physiotherapy and podiatry may require you to pay for an ‘extra services’ facility with much higher fees.

    If you have money to spare, it may be worth discussing these issues with children or potential heirs and carers so they realise that your home may have to sold or your capital may have to be used up if you need to go into care.

    • Hi Michael
      Many thanks for your contribution to the discussion. The articles are merely conversation-starters and prompts for readers to do their own calculations regarding their lifestyle needs. For example, some readers believe I am too conservative with my assumed investment returns. Other readers want the tables recalculated without Age Pension entitlements.
      I also use different assumptions to ASIC, as a means to protect the copyright of our articles.
      In response to your comment about the further out you plan, the harder it is to plan, I definitely agree, and these projections and plans should never be set in stone.
      A further complication, especially for couples relying on a part Age Pension, is if one member of the couple dies, then the Age Pension entitlement is often dramatically reduced due being subject to the single person’s assets test.
      In relation to the assumptions that I use, I am trying to provide as much information as possible without loading it with complexity, and I disclose the assumptions so readers can adjust the assumptions for different scenarios.
      In a future version of this article, I will include ASIC’s 4.5% indexation, alongside my 3% indexation.
      Regards
      Trish

  5. Hi Trish

    I have some doubt about the answer to the second reader question at the beginning of this article. Question 2 states in part “..I generate $140,000 (at 7% p.a.) …only withdraw $100,000 p.a…..”. The ASIC answer states that the reader is earning 4% p.a. in real terms but is taking out 7%. Clearly $100,000 is not 7% of $2m so the answer doesn’t seem to match the question.

    Regards
    Bruce

    • Hi Bruce
      Thanks for your email. Yes, I agree that is a clarity issue, which is due to expression rather than mathematics. I have amended the text slightly to say that return in real terms is 4% but the amount being withdrawn is more than 4% in real terms each year. The point of the comment from ASIC was to indicate that an indexed income stream increases each year in line with inflation, which means the money withdrawn in these circumstances eventually overtakes the returns at this level.
      Regards
      Trish

  6. Darryl Smith says:

    Hi Trish,
    I hope you can assist me.
    I have my own SMSF & retired several years ago.I just turnt 65 & i am about to become into a inheritance of $57000.
    I realise that I must pass the work test of working 40 Hrs within a 30 day period prior to putting this money into my super Fund.
    I would put it in as a non deductible contribution.
    Does this amount count towards a maximum of $450,000 over a 3 year period(assuming I pass the work test for the next 3 years)
    The reason I ask you this is,that I have 2 Property investments worth approx $800,000.
    To save on CGT,I would like to Contribute the maximum I can as deductible contribution
    Can you please assist
    Kind regards
    Darryl

  7. I make the following comments:

    (1) The essential, real-life costs – food, insurances, registrations, energy, to name but a few – for those who are retired increase far more than the mythical CPI so a doubling factor in any calculation for future funding is mandatory.

    (2) As a retiree gets older, health costs for those that wish to care for themselves increase significantly.

    (3) Only the well-off self-funded retirees can really afford the overseas trips; for me, having done all that – 5 star hotels, flying around the world, etc – during my working life my focus is now on 1 and 2 above.

  8. Terry Wenban says:

    After further thought this is an over simplification as it assumes everything you spend money on will rise with inflation and this is not the case. Many items have decreased in cost like imported goods, my golf membership, motor vehicles, overseas travel etc. So the only inflationary items are food and utilities and you can even reduce these with solar panels and changing habits to contrl the cost.
    Changing buying habits is the one factor economists don’t take into account when creating these comments and theories. This is the difference with the baby Boomer generation in that we have no issue with doing this as our priorities are different and we know what it is like to do without.
    So I would dispute this as it is very conditional and most probably written by a Gen X who doesn’t know what it’s like to make changes backwards.

  9. Hi Trish,
    Great article, got people thinking. I have read quite a bit your books/article included, I have read other views from those who profess such knowledge and have been to a range of seminars. Many views are conflicting and I am starting to believe that since the IFC noone really can offer authentic planning proposals it’s like the sea it will come and go as pleases and is often full of surprises even to the most experienced sailor.
    Regards
    John

  10. Terry Wenban says:

    I understand the figures produced and why the 1million wont last forever but inflation may not run at 3% nor may you be able to obtain 7%. With the way the world economies are running now all economists are more or making “guesstimates” of what they feel will occur. Somethings have run a lot higher than 3% and others have not risen at all plus the biggest contributing factor missing is that as you get older your lifestyle changes depending on how active you are and your previous lifestyle. I have already travelled the world with over 30 oversseas trips so travelling is still on the cards but not to the extent as others that have not already done so.
    So my point is every person is different, depending on your previuos lifestyle will depend how much inflation effects you. I have basically lived off the same income level for nearly 30 years now and changed my habits more than anything else. We have the 1 million, no debt and I would rather go earlier while we still have our health and maybe when 75 do the cut backs then when we are not so mobile.
    Liked the article though but the comonists of the world today are not doing such a good job predicting anything right now and I would rather depend on my own devices for the outcome rather than rely on someone else who has their own agenda. I wish it was different but who can you really tryst after the GFC.

  11. It is all true but as you get older, how much can you spend at age 80?

  12. Using some elderly relatives as an example, I noticed that their definintion of comfortable living changes as they get older. Eg. between 80 & 90, overseas travel has reduced, over 90, no overseas travel and less local / interstate travel. Luxury cars / goods are not important as they get older because most times they are unable to utilise them.

    The most important thing is good health and friends / family.

    My point is that although the cost of living increases, their requirement of certain things reduces so they probably negate each other. The $’s required in the later years can be reduced!

  13. Graeme Walker says:

    I have been following your discussion on retirement with $1M, $2M etc. but speaking from long, experience I would point out that several very important facts have been overlooked in all the suggested calculations. I am a retired financial adviser who retired at age 70 and am now 78. I advised clients on retirement planning for some 26 years.
    Firstly, when planning some 30+ years ahead you have to consider the cost of lifestyle changes which are not even in existence at day one. Just think about, for example, the cost of computers and internet usage for someone retiring 30 years ago! As a rule of thumb, I believe a retiree has to budget for double the expected CPI. e.g. if you expect inflation of 3% then budget for 6%.
    The next important factor is changing major expenses. Currently I plan a very comfortable oveseas trip each year but I know that at some point my health may not allow for this, so this would be a saved expense. There will come a point, if I live long enough, when I will not be able to drive a car – a very substantial saving which will be partially offset by increasing use of taxis.
    Although fully self funded, I can allow for the fact that if my capital falls significantly, a threshold which is continually changing, I just might become eligible for an Age Pension which would start to bolster my investment income.
    Then there is the question of what investment return do you use for budgetting. Based on my portfolio structure I budget for an average 8% return but we all know this could range from -20% (or more) to +20% or more in any one year.
    I have developed my own calculator which takes into account as many of these factors as possible and looks 20 years ahead. Each year I reset the starting point based on my then current assessment so I can now have an estimate of my position at age 98. However, if anyone thinks they can allow for all these factors at age 60 and budget for 40 years ahead I am afraid they will have a few surprises in store!

  14. Hi Trish thank you for this article. Many online calculators assume 7% returns over the long term, as in the one you use. That looks comfortable based on the last two decades, but the next two decades? The mountain of debt that hangs over the world economy makes me doubt it. I make my own long term calculations based on 5% and worry that even that may turn out to be optimistic. On that basis, when I look at what I’ll be earning when I’m in my eighties it doesn’t look so great. Then I think of how much money my parents and their parents had and realise I’ll be living like a king compared to them. My grandparents, who died in the 50s, 60s and 70s actually felt grateful that the government gave them a pension. Riches at last!

Leave a Comment

*