John had woken that morning to find that it was ...
John had woken that morning to find that it was finally here… the day had come… he had turned 55. It suddenly dawned on John, a sales rep, that he had exactly 10 years to ‘make hay’ before his planned retirement at age 65.  Paid on a monthly basis, this equated to only 120 remaining pay cheques for the rest of his working life before he was on his own.  John’s wife Judy, a nurse, was 2 years his junior but planned to retire at the same time as John in 10 years.
John and Judy Spence had paid off their house, raised a family of three, had some savings and a combined amount of $300,000 in their superannuation funds.  Whilst nervous about discussing their finances with a stranger, shortly after the Spence’s made an appointment with Lighthouse Financial Advisers Townsville to discuss what they needed to do to ensure they could retire in financial comfort.

“From our first meeting the team at Lighthouse made us aware that we could get to where we needed to be over the next 10 years” John commented.

The financial advice we gave John and Judy, was practical, results oriented and easy to understand. This was our approach.

Budget as if you are retired now.
The first thing that we looked at with the Spence’s is what their annual living costs would be right now in the hypothetical situation that they retired tomorrow.  This is great starting point because it gets you thinking about what types of things you might like to be doing in your retirement.  Right away we could work out that John and Judy’s basic living costs would be around $35,000. This includes expenses such as groceries, medical, home maintenance, land rates, insurances, etc.
After that we discussed what types of optional expenses that would be incurred in their ideal retirement.  Like most Australian’s, travel is something that is important to the Spence’s.  First on the agenda for John is a self-drive holiday around Great Britain.  Judy would also like to visit Canada shortly thereafter.  What we worked out is that during the first ten years of their retirement, it’s likely that John and Judy would travel overseas every second year for a total cost of $15,000 for each trip.  There would also be some less expensive domestic travel in between.  So we allowed for $10,000 of travel each year.  On top of that, with dining out, Cowboys season tickets, golf membership and other bits and pieces, we allowed for another $10,000 per year.  So in total, the Spence’s estimated budget of yearly expenses is $55,000 pa. in today’s dollars.  Allowing for assumed inflation of 2.5% pa., this means that in the first year of their retirement in 10 years’ time, they will need to be able to draw an income of $70,000 ($55,000 pa. in 10 years time indexed to 2.5% per year = $70,000).

Something to aim for.
Knowing that an income in the first year of retirement of $70,000 was the target, we could get to work in growing the Spence’s retirement savings.  Ideally, the target amount of retirement savings to have for the Spence’s is $1,400,000 (equates to ‘20 times’ the first year of retirement income needs of $70,000).   It sounds enormous, however, remembering that the day that the Spence’s stop going to work (and therefore stop earning an income), their retirement savings have to go to work to generate their required income.  Additionally, with health advancements improving all the time, it is not out of the ordinary to assume that at least John and/or Judy might spend 30 – 35 years in retirement, over a period of time when costs will almost certainly go up.

Room to move.
It’s always good to have some room to move in your budget.  Whilst John and Judy are seeking an income of $55,000 in today’s dollars if retired now, there is room to move. For example, if they need to, they have said that they could travel overseas every 3rd year as opposed to every 2nd year during retirement.  This means that their travel expenses could drop from $10,000 to $6,660 per year, saving them $3,440 pa.  Additionally, they have said that they could also drop their planned $10,000 of entertainment etc. (e.g. cowboys tickets, dining out, etc.) to $7,000 pa. saving $3,000 pa. and still enjoy a good lifestyle.

On top of that, the $35,000 that we have estimated for their basic living expenses also includes contingency expenses of $5,000 pa.  If only $2,500 of those contingencies were required during an average year, there is a further saving of $2,500.  Combined, this means that their overall expenditure budget reduces by $8,940pa ($3,440 + $3,000 + $2,500). So they could actually live off $46,060 pa. as opposed to $55,000 if they had to, and still live a good lifestyle.   The consequence of this is that if the Spence’s happened to fall short of the $1,400,000 target retirement savings for reasons outside of their control, with a reduced income they can afford to retire with less.

Getting to work.
The practical ways that we have helped the Spence’s take control of their retirement are:
  • Effective budgeting – After working out John and Judy’s expenses, we realised that they have a spare $450 per week ($23,400 pa.) that they can do something with. At first, they thought this was too much and how could they afford to part with $450 pw.  However, after realising that they have paid their mortgage off recently and two of their three children were now financially independent, we realised that $450 was not a stretch at all.   Additionally, the $450 spare per week was the amount after they have already paid income tax of 34.5%.  So they really had a spare $687 per week of before tax income that they could do something with ($687 before tax income less 34.5% income tax = $450 after tax per week).
  • Salary sacrificing to their superannuation – We were able to demonstrate that a better strategy was to salary sacrifice a combined $687 to their respective superannuation funds before they received the income and had to pay income tax on it.  By salary sacrificing the $687 to their super funds, the tax levied is only 15% as opposed to their income tax rate of 34.5%.  Besides the tax savings of 19.5%, The salary sacrifice of $687 per week will add an extra $415,000 to their combined retirement savings balance over the last 10 years of their working life.
  • Revising the investment strategies of their superannuation funds – Like most Australian’s, John and Judy had really given much thought to the investment strategies inside their superannuation fund.  As a result the investment strategy chosen by the super fund manager wasn’t entirely suitable for their objectives.  The likely average rate-of-return of the conservative strategy that their retirement savings were invested into was assumed to be 6% pa. after fees and taxes.  What if they could achieve an 8% rate-of-return from their super fund over the next 10 years?  By achieving an additional 2% rate-of-return (8% instead of 6% pa.), their retirement savings are bolstered by an additional $100,000 over a 10-year period.  We were able to help John and Judy understand how investments inside superannuation work, and how to invest for a higher rate-of-return, whilst ensuring that the additional volatility doesn’t result in unnecessary risks being taken.
  • The sum of all parts – By combining the salary sacrifice strategy of $687 per week ($415,000 better off) plus increasing the assumed rate-of-return from 6% to 8% ($100,000 better off) the Spence’s are on track to accumulate $1,213,000 of retirement savings by the 10 year mark (note – the Spence’s were originally on track for total combined retirement savings of $697,000 before coming to us, which was well short of where they needed to be).  Whilst not there yet (they are officially at the 5-year mark), they are certainly on track to achieve this result.  In addition to their super balances totalling $1,213,000, they also have plans to downsize their 5-bedroom home to a 3 bed which will provide an additional $150,000 to add to their superannuation savings.  This will provide them with $1,363,000 to enter retirement with.
  • A 0% taxed retirement – As John and Judy will be aged over 60 by their retirement, two very important tax consequences can apply; 1) the assumed rate-of-return of 8% that their retirement savings makes, provided that they convert their superannuation funds to Account Based Pensions, will not be taxed at all. At an assumed rate-of-return of 8%, this means that their retirement savings can make on average of $109,040 without any tax being levied; 2) John and Judy can draw their required income of $70,000 from their retirement savings and pay 0% income tax.  A 3rd very important aspect (which isn’t tax related) is this; John and Judy are drawing $70,000 of income (roughly 5% of their $1,363,000) from an assumed rate-of-return of 8% ($109,040) net.   In other words, they are taking $70,000 from an income of $109,040, meaning that their retirement savings actually grow by $39,040.  This is important as it means that they can draw a larger income the following year, which they most certainly would need to do considering that living costs will rise by an assumed 2.5%.

In summary, John and Judy Spence tell us that they are extremely happy with their progress. As their Financial advisers, we have a meeting every 6 months to keep them on track, measure their progress, adapt to changes in legislation and help them to manage changes to their personal lives (during the last 5 years this has included John being made redundant and then finding new employment as well as one of their daughter getting married) whilst ensuring that these changes do not derail their achievements.  They both wish that they came to see us earlier rather than later, however, I made the point that the important thing is that ‘they came to see us’.

Make an appointment with Lighthouse Financial Advisers Townsville today on 4772 0938. It’s never too late!

Calculations in Spence’s example are:  combined income of $160,000 before tax with employer super guarantee contribution of 9.5%, starting combined super balance $300,000, rate-of-return of super funds 8% pa. net of fees and taxes, salary sacrifice to super combined $687 per week for 10 years, legislation effective as at 21st October 2016.

Written by Michael Hogue.
Published by Michael Hogue November 3, 2016