Get ready for retirement: Your three-phase financial plan

Financial planning for retirement is more complicated than most people realise. For one thing, it includes budgeting for three different phases:

• Saving for retirement: calculating your savings target and how to reach it
• Transitioning to retirement: mapping out your transition from working life to retirement
• Living in retirement: ensuring you’ll have a sustainable income

Let’s explore how you can prepare for each phase of your retirement strategy.

Saving for retirement

Once you’ve pictured your retirement (including when you want to retire, where you want to live and what you want to do), you can start figuring out how much it will cost. Here’s a step-by-step guide to calculating that:

• Map out your current spending patterns (if you already have a budget, you can use that).
• Do you expect these to continue exactly as-is during your retirement, or will they be different?
• Adjust your budget accordingly, based on the retirement you picture for yourself.
• Check your budget against the ASFA Retirement Standard.

You can also use the ASFA Retirement Standard as a starting point to calculate your retirement budget, then adjust it based on your individual retirement goals. This standard benchmarks the weekly and annual budget needed by Australians to fund a comfortable or modest standard of living in retirement.

Here are some sample expenditures for retirees aged 65-84 (September quarter 2023):

Once you’ve calculated your cost of living in retirement, the next step is to convert this into a lump sum. This is your savings target, or the amount you’ll need to save by the time you retire.

Be sure to consider factors like:

• How long the money needs to last (i.e., how long you expect to live)
• Whether you want to leave an estate to beneficiaries, and if so, how much
• What your risk profile is and how that might affect the savings you can achieve through investments

With that target in mind, it’s time to set up a savings plan. Figure out how much you need to save yearly and then monthly in order to reach your target before you retire.

For example, let’s say you’re married, want to live comfortably, and plan to live until age 90. If you retire at age 65, that’s a total of 25 years you’ll need to budget for. If we just take the ASFA Retirement Standard yearly expenditure of $71,723.56, without making any adjustments for your personal retirement picture, and multiply it by 25, we end up with $1,793,089. In this scenario, that’s the amount you and your partner would need to save for retirement.

Most Australians use a superannuation fund for retirement savings, which your employer also contributes to. As you build up this fund, consider doing things like:

• Consolidating your super to minimise fees
• Making extra contributions when you can afford to
• Reviewing your super investment options to ensure you’re maximising your savings

It’s also a good idea to check your super at least once a year to make sure your employer is contributing, review your information and account fees and consider whether you want to change your investment options.

Start saving early: a case study

Bronwyn starts saving for retirement at age 30. With her current income and expenses, she can put $200 per month into her retirement savings. If she does this every month until she turns 65, she’ll put in a total of $84,000 of her own money. With a 7% per annum rate of return on her investments (compounded monthly), she’ll end up with a total of $360,210.92 by age 65.

Brenda, on the other hand, doesn’t start saving until she turns 55. To make up for lost time, she puts $1,000 per month into her retirement savings. By age 65, she will have saved a total of $120,000. With a 7% per annum rate of return (compounded monthly), she’ll end up with a total of $173,084.81 by age 65.

Even though Brenda is investing more than Bronwyn—both monthly and total—Bronwyn will end up with more than double Brenda’s retirement income. This is because she started saving sooner, which means her money started compounding sooner.

Transitioning into retirement

Once you reach your preservation age (between 55 and 60, depending on when you were born), you can access your super fund. At this point, if you want, you can set up a Transition To Retirement (TTR) strategy.

This means transferring some of the money in your super to a TTR account (usually an account-based pension) and either (1) reducing your working hours while using the money in the account to supplement your reduced income or (2) continuing to work full time while boosting your super and saving on taxes.

If you want to ease into retirement, you may prefer option 1. In this case, you’ll continue receiving super contributions from your employer, which will help replace the money you withdraw. You’ll also pay less taxes on your pension payments (if you’re 60 or older, they’re completely tax free).

Option 2 works best if you’re 60 or older and have a mid to high level income. With this option, you can use salary sacrificing to build up the funds in your super and save on taxes (15% on salary sacrificed contributions to your super). You’ll also get tax free pension payments if you’re over age 60. This option is a bit more complicated though, so you’ll probably want to consult a financial advisor before deciding if it’s right for you.

Transitioning to retirement: a case study

Camille makes $50,000 a year before taxes. At age 60, she decides to start easing into retirement by reducing her hours. Her new schedule includes only three days of work per week, which reduces her income to $30,000. To supplement her lower income, Camille transfers $155,000 from her super into a TTR account-based pension. Each year, she can withdraw $9,000 tax free.

Hayden, unlike Camille, wants to keep working full-time until age 65, then retire. He currently makes $100,000 a year before taxes. At age 60, he transfers $200,000 from his super into a TTR account-based pension. Then he makes a salary sacrifice to increase the funds in his super. This reduces his income tax, but it also reduces his take-home pay. To supplement his income, he withdraws up to 10% of the balance in his TTR pension each year.

Living in retirement

Planning your life in retirement includes ensuring a sustainable income, and that means managing any risks that might threaten that income. This is also called asset longevity, because it refers to making your assets last as long as they need to.

Risk 1: Running out of income

One of the financial risks you face in retirement is withdrawing too much income or withdrawing income too often. In this scenario, you’d be using up your retirement savings at an unsustainable rate, leading you to eventually run out of money.

This might happen if:

• You take out too much money to start with
• You make ad hoc withdrawals to cover expenses
• Your savings suffer due to a market downturn

To manage this risk, you’ll need to figure out your sustainable retirement income rate: in other words, how much money can you afford to withdraw per month if you want it to last for your entire retirement?

You can also minimise investment risk by diversifying your portfolio and doing your research to choose the safest investment vehicles.

Risk 2: Living longer than you budgeted for

Living longer than you anticipated is great, but what if you didn’t budget for those extra years?

The Australian Bureau of Statistics (ABS) publishes life expectancy statistics on a regular basis, and you can use these as an estimate of how long you’ll live. In 2020-2022, life expectancy was 81.2 years for males and 85.3 years for females.

But while this is a helpful estimate, it doesn’t necessarily mean that you won’t live past 85. In fact, it’s much more likely that these statistics are an underestimate for you.

To manage this risk, it’s a good idea to create a buffer. In other words, save for how long you think you’ll live, then add on a few more years just to be safe. If you don’t end up needing that money, you can always pass it on through your estate. And having plenty of money to retire on—even if you don’t end up using it all—will give you peace of mind and a greater ability to enjoy your golden years.