Note: This article is a supporting article to the two-part series, ‘Crunching the numbers: a $1 million retirement’ and ‘Crunching the numbers: a $2 million retirement’ (links for these articles are set out at the end of the article).
If you live off the earnings only 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.
Some of the most important questions you need to ask when planning for your retirement are:
- What type of lifestyle do you want? (see SuperGuide’s articles on how much super do I need?
- How long do you want this lifestyle? (see SuperGuide’s article Life expectancy: Will you outlive your retirement savings?)
- How much money do you have?
- What investment return are you hoping to achieve on your savings in retirement? (see SuperGuide’s articles on Is my super fund performing?, and also note that in many of our wealth articles we assume a 7% a year long-term investment return, or a 5% a year long-term investment return but you may have different expectations)
- Do you want to leave any money to your children? (see also SuperGuide’s articles on
- Is there a gap between your expectations and what you hope to achieve financially for your retirement?
In May 2013, we updated and revamped two articles on the SuperGuide website outlining what $1 million can deliver you in retirement, and what $2 million can provide in retirement. The two articles have been very popular articles on the SuperGuide website this year, and consequently I received many emails challenging the fact that $1 million could run out when earning 7% after
In collating the figures for the two features, I relied upon the Australian Securities & Investments Commission’s
Three popular questions from readers
Three questions from readers, and
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.
2. Reader question: I just don’t get it. If I have $2mil @ 7%, I generate $140,000 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 but are taking out 7%. If you start at age 65 with $2 million and draw $100,000 income per year (indexed to inflation) your funds are estimated to last until age 97.
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 $445,000* can deliver a couple nearly $56,000* (indexed) a year in retirement (which includes the couple’s Age
ASIC’s response: On an account balance of $445,000*, the MoneySmart Retirement Planner estimates the income (age pension + super) to be just under $56,000*. Using the account-based pension calculator to double-check figures, at 7% return after fees and 3% inflation, the allocated pension account can be expected to deliver an income of $33,600 for 22 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 $445,000 delivers $56,000 a year, assuming savings are invested in assets that return 7%, and annual income is indexed at 3%. SuperGuide’s calculations also assume no lump sum expenditure in the first year from the account balance.
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 $1 million and $2 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 $2 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 $54,500 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. In today’s dollars, Beverley’s annual retirement income for each year works out to be roughly $54,500 a year (although significantly more in tomorrow’s dollars).
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 (no fees or taxes), then Beverley’s money should never run out if she only takes out $54,500 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 $54,500 in 10 or 20 years’ time will not deliver her the lifestyle she wants. If Beverley withdraws $54,500 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 ASIC’s MoneySmart account-based pension calculator to calculate the income she needs to withdraw from your super pension each year in tomorrow’s dollars, to maintain today’s lifestyle of $54,500 (see table below), assuming 3% indexation/inflation. You can also do these calculations manually by multiplying $54,500 by 1.03%, and then multiplying that result ($56,135) 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 $54,500 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 | Today’s dollars |
| 65 (retires today) | $54,500 | |
| 66 | $56,135 | $54,500 |
| 67 | $57,819 | $54,500 |
| 68 | $59,554 | $54,500 |
| 69 | $61,340 | $54,500 |
| 70 | $63,180 | $54,500 |
| 71 | $65,076 | $54,500 |
| 72 | $67,028 | $54,500 |
| 73 | $69,039 | $54,500 |
| 74 | $71,110 | $54,500 |
| 75 | $73,743 | $54,500 |
| 76 | $75,441 | $54,500 |
| 77 | $77,704 | $54,500 |
| 78 | $80,035 | $54,500 |
| 79 | $82,436 | $54,500 |
| 80 | $84,959 | $54,500 |
| 81 | $87,457 | $54,500 |
| 82 | $90,080 | $54,500 |
| 83 | $92,783 | $54,500 |
| 84 | $95,566 | $54,500 |
| 85 | $102,914 | $54,500 |
| 86 | $101,386 | $54,500 |
| 87 | $104,418 | $54,500 |
Source: Incomes in tomorrow’s dollars (using 3% indexation) verified used ASIC’s account-based pension calculator and referring to the ‘Pension 1’ tab in the calculator.
Crunching the numbers: Retiring on $1 (or 2) million
Due to popular demand, we have created a 2-part special on what a $1 million lump sum can deliver you in retirement, and what a $2 million lump sum can give you as a single person, or a couple, and whether you retire at 55, or at 61 or 65, or even 67. Click on the article links below:
You may also be interested in an 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:
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.
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.
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
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.
It is all true but as you get older, how much can you spend at age 80?
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!
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!
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!