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One of the biggest challenges for retirees is working out how much of their savings they can afford to spend each year.
Fear of running out of money and a reluctance to seek financial advice means many people withdraw the minimum amount required from their superannuation account-based pension.
There have been many attempts to create a simple rule of thumb to help people estimate the amount of retirement income they should aim for, although most have been developed overseas.
But what if there was a simple, easy-to-remember rule of thumb to help Australian retirees work out the ‘’Goldilocks’’ pension drawdown? That is, an amount not so great you risk running out of money and not so small you live more frugally than you need to, but an amount that is just right.
It turns out there is.
Spend your age
An Actuaries Institute working group has devised a simple rule of thumb based on your age and assets. What’s more, by using this rule of thumb many retirees would draw down more income each year and enjoy a higher level of Age Pension entitlements over their lifetime.
“We know that many Australians defer to the statutory minimum drawdown from their account-based pension, but that was never intended to be guidance for how much you should or could withdraw,” says John De Ravin, one of five actuaries behind the research.
“I’m an actuary and when I retired three years ago, I found it hard to work out,” he says. That’s when he realised there must be a better way.
How it works
The group ran a range of calculations initially focused on single homeowner retirees who have reached Age Pension age and receive a full or part Age Pension in addition to an account-based pension.
They tested for pensioners of different ages and different levels of assets in bands of $20,000 to find optimal drawdown rates from age 67 to 110.
After doing these detailed calculations they were able to produce a simple, easy-to-communicate ‘rule of thumb’. (Their findings can be found in more detail in a in a paper titled Spend your decennial age.)
Here’s what they found:
- A single retiree should draw down a percentage that is the first digit of their age, for example, if you are 72 you withdraw 7% of your account-based pension
- Add 2% if your account balance is between $250,000 and $500,000.
The above rule is subject to meeting the statutory minimum drawdown rule.
Why stop at an account balance of $500,000?
De Ravin says they chose to test for assets of $250,000–500,000 because this came close to the Age Pension assets test range for a single homeowner.
“The optimal drawdown rates tend to be higher (for this group) than for a person with less assets than that and more than that,” he says.
A retiree with the same balance in their 70s would draw down 9% of their savings under the rule of thumb, while someone in their 80s would draw down 10%.
This compares with the current statutory minimum drawdown rates in the table below.
Note: The rates listed below are the normal minimum pension payment rates, rather than the temporary reduced rates applicable for the 2019–20 to 2022–23 financial years due to the impact of COVID. Learn more about the minimum pension payment rules (including calculator).
|Minimum withdrawal rate
|Rule of thumb
|6% (7% from age 70)
As you can see from the table, a person following the actuaries’ simple rule of thumb would withdraw more money than the statutory minimum up until age 84, but once they turn 85 they would be required under the current rules to withdraw more than the rule of thumb.
A need for Aussie rules
De Ravin says the study focused on retirees with an account-based pension to reflect current practice. Most Australians are members of defined contribution super schemes and use their retirement balance to start an account-based pension in the absence of annuity products with broad appeal.
While the working group looked at various rules of thumb used by retirees and their advisers, De Ravin says none are designed specifically for Australian conditions and the complex interaction with our Age Pension entitlements.
Extra fine tuning
De Ravin says that while the ‘spend your age’ rule of thumb is not perfect, it comes close. For example, a detailed calculation of Tom’s circumstances (above) would have indicated an annual drawdown of 8.82% of his account balance instead of the 8% under the simple rule of thumb.
For people who want to further optimise their drawdown amount, the working group developed two further refinements for:
- Retirees who are more engaged and actively manage their finances, for four balance groups and every five years of age between 75 and 95
- Financial planners, with recommended drawdown rates for each year of a client’s age from 67 to 95, for seven different asset levels from less than $200,000 to more than $700,000.
Why Age Pensioners only?
De Ravin says there is no reason why the simple rule of thumb wouldn’t apply to fully self-funded retirees. He says the reasons they were excluded from the detailed calculations were:
- More comfortably well-off retirees often want to leave a bequest whereas the rule of thumb assumes people use their super purely for their own lifetime benefit
- People with more assets are more likely to seek financial advice and receive assistance with their optimal drawdown rate
- They can often live comfortably off the income from their investments without needing to draw down capital.
If I spend more, won’t my money run out faster?
“The optimal drawdown rates are severely impacted by the Age Pension assets test. If you are under the assets test range, for every $1000 of your account-based pension you spend, the following year your income (from the Age Pension) is likely to increase by 7.8% because the taper rate in the assets test is so high”, says De Ravin.
In other words, by spending more some retirees will be able to have their cake and eat it too.
“By the time they reach 85 they will have less left in their account-based pension than if they had stuck to the statutory minimum but there is so much enjoyment of life to be had between the ages of 67 and 85. Expenditure also tends to decline as you age anyway, so we think (the rule of thumb) is a good trade-off.”
These thoughts were echoed in an April 2022 Actuaries Institute paper titled A framework to ‘maximise’ retirement income, by Jim Herrington and Andrew Boal. They argued:
Drawing the minimum is unlikely to maximise retirement income over the lifespan of each member. Doing so generally results in an overall drawdown pattern (including the Age Pension) that increases during retirement rather than giving the member confidence to increase their total drawdown in the first 10–15 years of retirement while the person is healthier and likely to desire a more costly lifestyle. Most people who draw down the minimum amount will have at least some unused balance remaining on death and in many cases it will be quite material.
What about aged care?
One of the shortcomings of the simple rule of thumb is that it makes no allowance for aged care, but De Ravin believes this is also an acceptable trade-off for increased happiness in the active retirement years.
“Only a certain proportion of Australians will need aged care, which means it’s hard to plan in advance.
“If you need aged care and funds are low at an advanced age, we have means-tested aged care. It might mean you wait longer and have less choice of aged care providers than if you had your own funds, but it’s another trade-off we think many people would be happy to take,” he says.