In this guide
Short of having a degree in actuarial studies or a crystal ball, most of us settle for guestimates where retirement planning is concerned. That’s where rules of thumb come in.
Rules of thumb, or heuristics if you want to get technical, are popular shortcuts based on practical experience or, in this case, population averages. They won’t be 100% accurate in all cases but they offer a starting point to get you thinking about where you should set your retirement income target.
These days, rules of thumb used in financial planning are often based on computer modelling using historic averages, demographics and other statistics. They can be useful planning tools in the absence of detailed information, but they are no substitute for a personalised financial plan.
We’ve collected some popular rules of thumb used in retirement planning, their origins, usefulness and limitations.
The 66–80% target replacement rate for retirement income
It can be difficult to know exactly how much income you will need in retirement. But assuming most people will hope to continue the same standard of living they have come to enjoy, it makes sense to use pre-retirement income as a guide.
SuperGuide’s retirement planning articles often suggest you will need somewhere between two thirds (66%) and 80% of pre-retirement net income to continue to enjoy your current standard of living.
This 66–80% rule is often quoted by financial advisers and financial publications. Sometimes it is simplified further to the 70% rule.
A target replacement rate of around 70% of your pre-retirement income (after tax and super contributions) is recommended by the OECD, the Melbourne Mercer Global Pension Index, the Grattan Institute and the 2013 Cooper Review among others.
Why 66–80%?
You may be wondering why your target replacement income in retirement is not 100% of the income you enjoyed during your working life. Where did the figures of 66–80% or 70% come from?
The reason is simple. It is generally cheaper to live in retirement. Housing and other costs typically fall, while government support from the Age Pension and other benefits and concessions increases.
As well as making mortgage payments, pre-retirees may be making voluntary super contributions or repaying investment loans that will ideally be paid off before they finish paid employment.
In a 2018 report, the Grattan Institute said it used a 70% target on the basis that most retirees own their home in retirement, no longer incur expenses related to work or raising children and substitute eating out for more eating at home. Retirees who rent will need to replace a higher share of their pre-retirement income to cover their higher housing costs through retirement.
The 70% target income includes the Age Pension and income from super but not non-super savings.
Most retirees can look forward to paying little or no tax, so the starting point for your target retirement income is household income after tax in the 10 years or so leading up to retirement. You then deduct mortgage repayments, work-related expenses and any other costs you will no longer need to cover. The dollar figure you end up with as a percentage of pre-retirement net income is the amount of income you will need to replace with a super income stream, the Age Pension and any other sources of income you can expect in retirement.
The Retirement Income Review 65–75% replacement rate
The government’s Retirement Income Review (RIR), which reported in July 2020, drew on research mentioned above by the Grattan Institute and others to recommend the use of target replacement rates to estimate retirement income needs. Rather than reduce the target to a single figure, the RIR suggested a replacement range of 65–75% would be appropriate for most Australians.
The RIR argued that replacement rates are preferable to the most common alternative in Australia – budget standards (see below) – because they provide income targets based on the income a person earned while they were working. This has the advantage of ensuring you continue your pre-retirement standard of living throughout your retirement years, with one very big caveat.
The RIR conceded that a target of 65–75% of pre-retirement income would not be enough to prevent poverty in retirement for Australians in the bottom 20% of income earners. For this group, the safety net of the Age Pension and other government supports will be necessary.
Super Consumers Australia retirement savings targets
The latest attempt at a retirement target rule of thumb comes from Super Consumers Australia (SCA).
Like ASFA’s Retirement Standard, SCA’s targets are based on spending, not income.
But unlike ASFA’s Retirement Standard, which is based on the cost of a basket of goods and services, SCA’s targets are based on the most recent ABS data of retirees’ spending. And where ASFA provides targets for two levels of spending (modest and comfortable), SCA has three levels of spending (low, medium and high). Yet despite these differences, the target outcomes are remarkably similar, with ASFA’s comfortable target sitting between SCA’s medium and high targets.
SCA’s target levels of spending, and the retirement super balance needed to achieve this level of spending, are set out in the table below.
Retirement savings targets for current retirees (aged 65–69)
|
Situation |
And you’d like to spend this much in retirement* |
Then you need to save this much by the time you are 65 |
||
|---|---|---|---|---|
|
Spending level |
Per fortnight |
Per year |
||
|
By yourself |
Low |
$1,115 |
$29,000 |
$73,000 |
|
Medium |
$1,462 |
$38,000 |
$258,000 |
|
|
High |
$1,962 |
$51,000 |
$743,000 |
|
|
In a couple (combined spending) |
Low |
$1,615 |
$42,000 |
$95,000 |
|
Medium |
$2,154 |
$56,000 |
$352,000 |
|
|
High |
$2,885 |
$75,000 |
$1,021,000 |
|
*Spending levels in today’s dollars adjusted for inflation, based on historic ABS data about retirees’ spending.
Source: Super Consumers Australia
The assumptions behind these targets are:
- Retirees own their home outright (no mortgage)
- Based on pre-retirement spending at age 55–59
- Average retirement age of 65, two years prior to Age Pension eligibility
- Retirees will be eligible for the Age Pension (reflected in the relatively low target retirement savings for all but wealthier retirees)
- Savings of $25,000 outside super (consistent with the MoneySmart retirement planning calculator and Age Pension eligibility)
- Investment returns of 5.6% in retirement net of fees and taxes, invested in a Growth option with 60% growth assets
- Income to last until age 90 with 90% confidence it will not run out
- Above minimum super pension drawdown rates for a substantial part of retirement (see section on minimum pension drawdown rules below)
- Average future inflation (as measured by the CPI) of 2.5% and wage growth of 4%.
In future, SCA will consider splitting spending levels based on location (metro/regional) and may include targets for retirees who rent. At present, 74% of retirees aged 65 and over own their home, but the proportion of retirees renting or with a mortgage is expected to grow.
The 10/30/60 Rule
Superannuation is commonly viewed as a bucket of money you fill up while working. On the day you retire, you turn on a tap and gradually drain the bucket until empty. No wonder retirees often withdraw the minimum amount required under the pension drawdown rules (see below) in case their money runs out too soon.
What people often overlook when planning their retirement income is that the investments supporting your super pension continue to grow in value throughout retirement.
That’s where the 10/30/60 Rule comes in. This rule of thumb highlights the fact that not only does our nest egg keep growing after we retire, but around 60% of our super pension income is likely to come from investment earnings after we retire.
This is the typical breakdown of where your retirement income comes from:
- 10% comes from money you saved while you were working
- 30% comes from investment returns on your savings before you retire
- 60% comes from investment returns after you retire.
The actual investment returns over your lifetime will depend on your appetite for risk and the mix of assets you invest in. However, the 10/30/60 Rule highlights the importance of maintaining a mix of investments in retirement that will generate returns that are sufficient to support your income needs.
Minimum pension drawdown rules
When you retire and start an account-based pension with your super savings, you are required to withdraw a minimum amount each year depending on your age. This amount is expressed as a percentage of your account balance as at 30 June the previous financial year.
Normally the minimum drawdown percentage factor begins at 4% if you are aged under 65 and rises gradually to 14% when you are 95 or older (see table below). These government-mandated rates are a rule of thumb based on advice from the Australian Government Actuary. It determined that most people would spend most of their super at these rates, without leaving too much to the kids.
However, the normal rates were temporarily halved following the sharp fall in asset values due to the coronavirus. This was so that retirees were less likely to be forced to sell assets and lock in losses to meet their minimum pension requirements.
| Age of beneficiary | Temporary percentage factor (2019–20 to 2022–23) | Normal percentage factor (2013–14 to 2018–19, 2023–23 onwards) |
|---|---|---|
| Under 65 | 2% | 4% |
| 65–74 | 2.5% | 5% |
| 75–79 | 3% | 6% |
| 80–84 | 3.5% | 7% |
| 85–89 | 4.5% | 9% |
| 90–94 | 5.5% | 11% |
| 95 or more | 7% | 14% |
Source: SIS Act
Bengen’s 4% Rule
When it comes to rules of thumb to help retirees work out how much income they can safely withdraw from their retirement savings each year, all roads lead to Bengen’s 4% Rule.
William Bengen was a Californian financial planner. In 1994 he worked out that the average American retiree could withdraw up to 4% of their nest egg in their first year of retirement then adjust that amount for inflation in subsequent years and have a 90% chance they would not run out of money for at least 30 years. So someone who retires at 65 could expect their money to last until they turn 95 with a 90% success rate.
Bengen based his 4% rule on actual returns over rolling 30-year periods between 1926 and 1992. He argued that 4% would hold for an asset allocation of 50–75% shares with the remainder in bonds, but a portfolio with closer to 75% shares had a higher probability of lasting longer.
This formula differs from Australia’s minimum pension drawdown rules, which are based on a percentage factor that begins at 4% (like Bengen) for people under 65 and increases as you age rather than adjusting for actual inflation rates.
Spend your age
One of the criticisms of our minimum pension drawdown rules is that many retirees treat them as maximums due to a fear of running out of money and a reluctance to seek financial advice.
A group of Australian actuaries decided there must be a better way to estimate how much retirees can safely withdraw each year; an amount not so great you risk running out of money and not so small you live more frugally than you need to. It also had to be simple and easy to communicate.
The result was a rule of thumb based on your age and assets they called Spend Your Age. Here’s what the group from the Actuaries Institute found:
- A single retiree should drawdown 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.
As you can see from the table below, a person following the actuaries’ rule of thumb would withdraw more money than the statutory minimum up until age 84. However, once they turn 85 they would be required under the current rules to withdraw more than the rule of thumb.
| Age | Minimum withdrawal rate | Rule of thumb |
|---|---|---|
| Under 65 | 4% | – |
| 65–74 | 5% | 6% (7% from age 70) |
| 75–79 | 6% | 7% |
| 80–84 | 7% | 8% |
| 85–89 | 9% | 8% |
| 90–94 | 11% | 9% |
| 95+ | 14% | 9% |
While the working group looked at various rules of thumb used by retirees and their advisers, such as Bengen’s 4% Rule, none are designed specifically for Australian conditions and the complex interaction with the Age Pension.
By spending their age, many retirees could draw down more income each year and enjoy more Age Pension over their lifetime.
The bottom line
Rules of thumb such as the 66–80% replacement rate, the 10/30/60 Rule, minimum pension drawdowns, Bengen’s 4% Rule and Spend Your Age are handy tools in the absence of detailed information. But they do have limits.
For starters, they are based on population averages and you’re not average. Some, like Bengen’s 4% Rule, are based on overseas experience. Also, they are based on historic returns, so they won’t tell you with any certainty how the future will unfold. For these reasons, while rules of thumb are a good starting point, they are no substitute for retirement income planning based on your personal circumstances.
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