Retirement income rules of thumb: Do they measure up?

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 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 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 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 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 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.

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’ 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 this level of spending, are set out in the table below.

Retirement savings targets for current retirees (aged 65)

*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 6% in retirement net of fees and taxes, invested in a Growth option with 60% growth assets (based on 25-year historic average)
• 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%.

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. 

The 10/30/60 Rule