The number one question in retirement planning is ‘how much will I need for retirement?’. This is an impossible question to answer with precision because of unknowns such as how long you are going to live and what return your super will get in retirement, but also due to the vast number of variables that can change over time, such as how much you spend in retirement or whether you keep working.
Over the years there have been many powerful calculators developed that can give detailed personalised projections for a single or couple, but their accuracy is only ever based on their assumptions, which will never be completely correct, and projected returns, which can never be guaranteed.
Recently there has been significant advances in the way retirement calculators are being designed. Advanced calculators, called ‘stochastic’ models, mean that users are no longer required to assume how long they are going to live or what investment returns will be. Instead, the models do this for you by testing thousands of plausible scenarios for future market returns and people’s lifespans – all weighted by the probability that each scenario may occur.
The scenarios tested take into account your age, health status and the investment profile of your retirement savings (superannuation and non-superannuation savings) as well as current market conditions.
Surveys show that top concerns of people in retirement relate to the fear of outliving their savings. Poor market performance, inflation, spending too much or living longer than expected are commonly cited concerns.
Stochastic models are able to determine a probability of being able to achieve a certain living standard throughout retirement, as well as other consumption goals, so that people can make informed trade-offs that take into account uncertainty and achieve their required confidence level. A simple example of this might be that a retiree can spend $70,000 per annum in retirement with a 50/50 chance of not running out of money in old age or spend $50,000 per annum and have 95% chance of not running out (even if markets perform poorly, living costs increase or they live longer than expected).
Actuaries and investment specialists can calculate a range for uncertain variables such as market returns, inflation and a household (joint) lifespan. An Economic Scenario Generator (ESG) is used to generate a collection of simulated economic scenarios which represent a distribution of plausible economic futures ranging from market highs to stock market crashes. This approach is now commonly used by large financial institutions globally such as banks and insurance companies as part of their risk management processes. The theory and science has evolved considerably as computer power has increased.
By using an underlying investment simulation model, retirement calculators are able to map out the range of outcomes that a household faces – including the impact of things like the means tested Age Pension and non-super savings. This enables retirees to quantify issues to a much deeper level than was common practice even a decade ago. It helps retirees to align their financial planning decisions (e.g. spending level) with the level of confidence that suits their risk preferences.
Some examples of the results from a stochastic model are provided below. These have been provided by retirement modelling specialists, Jubilacion, using software built by the specialist actuarial consulting firm, 10E24. 10E24’s model considers 5,000 sequences of possible future year-by-year returns from any investment mix as well as key economic variables such as inflation.
In the video below Jim Hennington takes a more in-depth look into modern retirement modelling, or scroll down to read case studies that assess how much super a household needs to retire using stochastic modelling.
Case studies: How much super does a household need to retire?
The examples below have been provided by actuary Jim Hennington of Jubilacion using specialist modelling tools for Australian retirees.
In all of the following examples, the retirees are assumed to own their own home. Their total spending level can be supported from a number of sources including spending from the superannuation and income they receive from the Age Pension. The spending levels are calculated to be able to keep pace with the cost of living over time. Couples spending is assumed to reduce by 30% should one of them pass away.
In each case they are assumed to put all their superannuation in an account-based pension product offered by a typical industry fund, invested in a Balanced option (60% growth assets).
In each case we focus on what their level of ‘safe’ spending (the lifestyle they can achieve no matter how long they live or what market performance turns out to be). The safe spending figures have been calculated as the amount that gives them 95% confidence that it is sustainable for life – without running out of savings. It is assumed they wish to always keep their home (which will eventually become a bequest for their children or fund their aged care).
- Male and female, both aged 67 and both in average health
- $30,000 of personal assets (car, furniture, etc)
Spending level in retirement
Safe spending* of $50,000 per year
Note: Higher spending than this would mean having less than 95% confidence it could last for life. For example, they could spend $58,000 per year and have 50% confidence that this could last for life.
Estimated superannuation required
$420,000** (combined)
Note: The Age Pension helps to support their spending level
- Male and female, both aged 67 and both in average health
- $30,000 of personal assets (car, furniture, etc)
Spending level in retirement
Safe spending* of $80,000 per year
Note: Higher spending than this would mean having less than 95% confidence it could last for life. For example, they could spend $113,500 per year and have 50% confidence that this could last for life.
Estimated superannuation required
$2,020,000** (combined)
Note: The Age Pension provides very little assistance to support their spending level
- Female aged 67 in average health
- $20,000 of personal assets (car, furniture, etc)
Spending level in retirement
Safe spending* of $40,000 per year
Note: Higher spending than this would mean having less than 95% confidence it could last for life. For example, they could spend $49,000 per year and have 50% confidence that this could last for life.
Estimated superannuation required
$640,000**
Note: The Age Pension helps to support their spending level
- Female aged 67 in average health
- $20,000 of personal assets (car, furniture, etc)
Spending level in retirement
Safe spending* of $50,000 per year
Note: Higher spending than this would mean having less than 95% confidence it could last for life. For example, they could spend $69,000 per year and have 50% confidence that this could last for life.
Estimated superannuation required
$1,210,000**
Note: The Age Pension provides very little assistance to support their spending level
*Safe spending means there is 95% confidence that this lifestyle can be sustained for life.
**Important notes for all the above scenarios:
- For couples, their total superannuation above was apportioned between both their names.
- In any years where their incoming cashflow exceeds the above spending level, they are assumed to save the excess. In any years where their incoming cashflow is below the above spending levels they are assumed to make additional withdrawals from their retirement savings to sustain their spending.
- Where they would receive a (means tested) Age Pension later on in retirement (for example as they spend down their superannuation) this has been allowed for in the calculations and can mean they support higher spending throughout their retirement.
- The maximum level of Age Pension is assumed to increase with price inflation, which is a conservative assumption compared to current policy.
- If market performance turns out to be favourable then they may decide to review their results and spend some of their extra gains.
- Please also refer to the section below “Warning: Why your scenario will differ from other retirees”.
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