Two questions people spend a lot of time thinking about as they approach retirement are how much they will need to live on in retirement and how much they will need in their super fund to generate that income.
These questions have also been a hot topic of debate in the superannuation industry, following an attack by the Grattan Institute on a widely used benchmark, the Association of Superannuation Funds of Australia’s Retirement Standard.
The ASFA Retirement Standard is based on an index of the cost of living in retirement. When it was last updated in March, it estimated that a couple aged around 65, who owned their home, would need income of $61,061 a year to live comfortably. A single person aged 65, who owned their own home, would need $43,255 a year to live comfortably.
The superannuation balances at retirement required to generate those incomes are estimated to be $640,000 for a couple and $545,000 for a single person. The earning rate on the funds producing the retirement income is assumed to be 6 per cent a year.
ASFA says a couple would need $39,848 for a modest lifestyle and a single would need $27,646
In a report published last November, ‘Money in Retirement: More Than Enough’, the Grattan Institute argues that Australians don’t need that much money to have a good retirement.
It says ASFA’s comfortable standard would support an affluent lifestyle more luxurious than most Australians currently have during their working lives “and it misleadingly suggests that anyone with fewer resources will have an ‘uncomfortable’ retirement.”
Speaking at the Actuaries Summit last week, Grattan Institute chief executive John Daley said ASFA’s benchmark was flawed because its modelling was based on outcomes for the top 20 per cent of income earners.
He said it assumed constant spending in retirement years, whereas it was well established that spending drops off significantly after age 75 or 80.
And he said ASFA did not properly account for the Age Pension. “Most people get a part pension and we have calculated that it will be about half of average total retirement income,” Daley said.
Daley also says that increasing the super guarantee from 9.5 per cent to 12 per cent will have less of an impact than people assume because of the effect it will have on reducing pension payments.
David Knox, a senior partner at Mercer, said he had some issues with the Grattan analysis.
Grattan measures income replacement rates based on a calculation of the last five years of working-life income. “Many people wind down in the last few years of work but living standards are set in the 40s and 50s when they are at their earnings peak,” Knox says.
Grattan assumes that people work through to age 67, which will be the Age Pension eligibility age from 2023.
“Australia does not have an official retirement age and many people leave the workforce before age 67. We need to model for people retiring at 62 or 64,” Knox says.
Grattan bases its modelling on life expectancy of 92, which Knox says ignores the many people who live much longer.
Grattan’s modelling is based on single people, but Knox says outcomes for couple can be quite different, especially when it comes to Age Pension eligibility.
Knox also says the Grattan modelling does not take account of falling home ownership. Renters have much higher expenses in retirement.
“We need to consider a much broader range of realistic expenses,” he says
Knox estimates that when all his criticisms of Grattan’s modelling are factored in, it reduces the working-life income replacement rate of the Grattan work from its base case of 89 per cent to 63 per cent, which is below the industry’s target replacement rate of 70 per cent.
So where does that leave people approaching retirement? Knox says the ASFA Retirement Standard is a useful tool for tracking the change in cost of living in retirement but people should be trying to work out wat they will need in retirement based on an income replacement calculation.
He says we all have lifestyle expectations based on the income we earn in our 40s and 50s and we should be looking at replacing about 70 per cent of that income.
An OECD study in 2013 found that in 34 OECD counties the replacement rate in retirement for workers on median salaries was 58 per cent. Replacement rates for women are lower in most countries.
In Australia the figures were 60.2 per cent for men on median income and 55.8 per cent for women.
When people are doing these calculations they need to keep in mind that at some point the Age Pension or a part-pension will kick in for most retirees.
Another point to note is that once we hit our 80s our sending drops off quite a bit, as we are less inclined to travel.