A common question we often get asked is “How much do I need to retire?”
Obviously this depends on many factors such as; the age you and your spouse stop working, how long you live for, how much you will need to live on each year and how the money is invested.
A US Study on safe superannuation withdrawal rate
In 1994, a study was undertaken in the US to help answer this question. The purpose was to determine a safe percentage rate that could be withdrawal annually from a pool of funds that needed to last 30 years. The funds were invested 50% in US stocks and 50% in US bonds. Income payments increased each year to account for inflation. Using historical average rates of return, the study concluded that 4% of the account balance could be safely drawn each year to make the money last. Given this is based on US data, it posed a good question.
Safe Superannuation Withdrawal Rate in Australia
Can we use this same rule of thumb here in Australia? Morningstar decided to answer this question by applying it to our own historical investment and inflation data as well as management fees that are typically charged here. The results concluded that a safer withdrawal rate would be closer to 2.5% per year. This implies that a retiree needs approximately 40 times their desired annual income saved to achieve this. In other words, if you wanted to achieve $50,000 per year to safely last 30 years, you would need a starting balance of $2m. While most people will likely fall short of saving $2m in retirement assets, it may not necessarily need to be made up of solely superannuation savings. Retirement investments may include the value of the family home or a business, which can eventually be sold. Those who will be able to qualify for the Age Pension need not worry about saving for this regular income to be generated from as a lump sum of money.
The study also produced some interesting tables that showed the probable safe drawdown rates for different lengths of time using different allocations to growth assets. For a balanced portfolio to last 40 years with 99% certainty, the safe withdrawal rate is 2.2%.
An important part of the study concluded that historical returns used have been higher than expected and we should all lower our expectations going forward.
Australian Government Superannuation Drawdown Requirements
If we compare the safe drawdown rate to the rules of the superannuation system in Australia, it is interesting to note that drawing 2.5% of capital each year is much lower than the minimum drawdown rates that the Government requires retirees to draw as an annual income stream. For example, someone with an account based pension that is aged between 55 and 64 must draw a minimum of 4% of their account balance each year. This percentage continues to increase as the account holder gets older. If 2.5% appears to be the right number, then why does the Government make you take more? This is to ensure that the money you have accumulated in a tax-effective environment is being spent and not merely saved as a wealth transfer tool. In some cases, for those over age 65, we have found the complexities and minimum drawdowns of super to be too great to justify, particularly if the additional income is not needed.
It should be noted that this study is general in nature and should not be relied upon as personal advice.