In this guide
Short of having a crystal ball, most of us settle for guesstimates when it comes to how much we need to save and how much income we will need to live comfortably in retirement. That’s where rules of thumb can help.
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 70% target replacement rate for retirement income
It can be difficult to know exactly how much income you’ll need in retirement. But assuming most people will hope to maintain their current standard of living, it makes sense to use your 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 and the Grattan Institute, among others.
Why 70%?
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, provided you own your home, while government support from the Age Pension and other benefits and concessions increase.
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 homes in retirement, no longer incur expenses related to work or raising children and substitute eating out for more eating at home.
Retirees who rent or who still have mortgage debt 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 65–75% replacement rate
The government’s Retirement Income Review (RIR), which reported in July 2020, also recommended the use of target replacement rates to estimate retirement income needs. Rather than reduce the target to a single figure, it 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.
Budget standard rules of thumb
Budget standards estimate the cost of a basket of goods and services likely to provide a given standard of living.
The best-known example of this for Australian retirees is the Association of Superannuation Funds of Australia (ASFA) Retirement Standard. This provides ‘modest’ and ‘comfortable’ budget estimates that are updated regularly for changes in the cost of living.
At the time of writing, a comfortable budget was estimated to be $77,375 for couples and $54,840 for singles. A modest budget was $51,299 for couples and $35,503 for singles.
ASFA estimates couples would need combined savings at age 67 of $730,000 to achieve a comfortable lifestyle, while singles would need $630,000. You will notice the savings target for a single person is much more than half of the couple’s target, reflecting the fact that two can live more cheaply than one.
While ASFA budgets are simple and easy to communicate, they do not reflect your personal spending habits or lifestyle. One person’s ‘comfortable’ may be another person’s idea of penury.
Learn more about ASFA’s Retirement Standard.
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 Australian Bureau of Statistics (ABS) data of retirees’ actual spending. And where ASFA provides targets for two levels of spending (modest and comfortable), SCA has three levels of spending (low, medium and high). While the low and modest targets are similar, ASFA’s comfortable target sits between SCA’s medium and high targets.
SCA’s target levels of spending and the retirement super balance needed to achieve it are set out in the table below.
Note
The target savings figures in the right-hand column are on top of income from the Age Pension.
Retirement savings targets for current retirees (aged 65)
|
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 |
$1,230 |
$32,000 |
$74,000 |
|
Medium |
$1,690 |
$44,000 |
$322,000 |
|
|
High |
$2,350 |
$61,000 |
$891,000 |
|
|
In a couple (combined spending) |
Low |
$1,810 |
$47,000 |
$99,000 |
|
Medium |
$2,460 |
$64,000 |
$432,000 |
|
|
High |
$3,420 |
$89,000 |
$1,216,000 |
|
*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 include:
- 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)
- 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).
At present, around 75% of retirees aged 65 and over own their home, but the proportion of retirees renting or with a mortgage is expected to grow.
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