Try and picture how you might feel when you retire… You are day one on the retirement journey and have just finished 30, 40 or even 50 years of your working life. Now you are facing your future life with more time on your hands than ever before, and your pay cheques have stopped! Can you even imagine this?
I have talked in depth with many people at this point in their life and I can give you this insight – your main financial concern will almost certainly be the longevity of your funds. So, the effort you put into effectively managing your finances now, will make all the difference for how much you’ve got when you do retire, to make sure that it will be more than enough to last you.
In this piece, I will help you determine what you should be thinking about to help make your retirement a successful transition, including defining what you value and are wanting to achieve; determining how much you need to retire; and structuring yourself to maximise the longevity of what you have.
What do you value in life and what are you trying to achieve
Your values
As a starting point, take time to consider the things you value in life. We ask clients to write them down and then add a description of what each means to them. It could be health, family, experiences, fun, faith – anything that makes you, you.
~Novel Serialisation: Heavens Fire~
This sounds easy, but don’t be surprised if you find the process more challenging than you think. Especially if you don’t contemplate it much.
The advantage of connecting your plan for retirement to what you value most in life comes in two distinct ways; Firstly, it will help you prioritise how you use your time in retirement; Secondly it will help you understand the financial tie backs that exist.
We place a lot of emphasis on this with clients, because it helps us really get to the core of what’s important to them and then once your values are clearly defined, you will find it provides a foundation for constructing your retirement plan and then keeping it on track overtime.
Your goals and objectives
I expect you have a pretty good idea of what you would like to achieve in life financially. It may be upgrading or downsizing your house, giving your kids and grandkids a good education, spending time overseas or retiring comfortably.
To breathe life into these and to help ensure they happen, it’s important you commit these goals to paper and prioritise them, because there is a proven correlation between people who achieve their goals and those who have committed them to paper.
Your financial plan for retirement is about prioritising and charting your key goals and objectives on a timeline, then documenting how these will realistically be achieved. It is one of the most important financial planning steps, because the financial strategies you choose to implement should be informed by what you are trying to achieve and then compliment this.
How much do you need to retire?
The answer to this question is highly personal, as it depends on things like your income requirements, the age you want to retire, lump sum expenses you want to allow for, how your funds will be invested, whether you will be eligible to any government support, and finally how long your funds must last.
We’ve broken down each of these points and some of the key considerations your financial planner should consider for you or that you can factor into your retirement income calculation otherwise.
How much you need and how much you want
By breaking down what you need, it allows you to calculate the minimum amount you require, for the rest of your life. By then separately defining what you want, you can see the difference, which will ideally demonstrate you can afford both your needs and your wants, but otherwise provide yourself a means of prioritising your wants, if you cannot.
The age you want to retire
Your retirement age is fundamental to determining how many years the money needs to last for, to achieve your goal. It stands to reason that the younger you want to retire, the bigger the lump sum is that you will need to achieve your objectives. Allowing for age differences between couples, is a complexity that also needs to be considered.
What lump sum expenses do you expect or would you like to plan for
I would suggest you break this into three groups being financial assets; lifestyle assets; and personal goals. Financial assets are investments that you are making, specifically for meeting your future income needs. Lifestyle assets include money tied up in things like your home, a holiday house or a car. Personal goals, include lump sum expenses you expect or want to plan for like family holidays, assistance/legacy for the kids or an outstanding tax bill.
How you invest your funds
How you invest will determine your investment return, which is fundamental to any retirement calculation. If all of your money was invested in cash for example, the lump sum you will need would be higher than someone who also invests in growth assets like shares and property. Structuring your investment strategy carefully and maintaining it regularly is fundamental to longevity of your funds in retirement, so pay attention not only to what level of volatility you can stomach, but also ensuring you have enough liquid investments to draw down on to meet your income and lump sum needs.
Age Pension Entitlement
In Australia for example, over 70% of current retirees receive some Age Pension and it is therefore essential to factor this into your retirement income estimate. The problem with most retirement income calculators however is that they don’t include potential age pension entitlement because there are too many personal variables that can influence the outcome. Yield’s Financial Planners account for potential age pension entitlement, and you should check to ensure that yours will too.
Longevity and life expectancy
Life expectancy is the great unknown, but to accurately predict how much you may need in retirement, you must determine how long you would like or need the funds to last for. The median life expectancy for a 65-year-old male is 84.9, and for females it is 87.6. We typically project until 90, recognising that as life travels on, income needs typically reduce. Importantly life expectancy is a constantly moving target, as the longer you live, the median is only made up of people who have lived longer than you at that point.
Structure yourself to maximise longevity of the funds you have
How you use your money while you are working, could make a big difference to your final retirement position. Your working life is your opportunity to make the money you need to live your life now, while also providing for your retirement years and its therefore valuable to understand what you can do to make your money stretch further.
In this section we will provide a focused look at growing your superannuation; having a plan for your free cashflow; investing your savings or accumulated capital; focusing on legally reducing the tax that you pay; structuring your debt properly; and protecting your downside.
If you can get each of these things right, your financial plan does not need to be difficult. It can also truly work for you, so you can work a little less or retire sooner.
Growing your super
Superannuation is the biggest retirement asset for most Australians and stands to only get bigger, with current employer contributions of 10.5% and that are set to increase to 12% by 2025. Superannuation is a highly tax effective place for you to invest for your retirement and depending on the super structure you go for, offers almost the same flexibility as you have personally, in what you choose to invest in. The key things that will determine the performance of you super include:
- Cost – weigh up what the fund costs vs the value of what you get
- Your asset allocation – how you split your money up between cash, fixed interest, property and shares is the biggest determinant of return usually over time
- The investments you choose – investment selection is the other major determinant of return. Choosing an investment that outperforms the median of the asset class is the objective
- Pension – usually setting up a pension when you are allowed is ideal, as you convert your super from a taxed to a tax-free environment
- Your contributions – there are various ways for you to make personal contributions to your super and when tied to your retirement income objectives can compound your overall investment return very well
Your free cashflow
Your saving capacity is one of your greatest assets and how you use it will make a big difference. Putting savings in the bank for example will yield a risk-free return, but likely produce the lowest overall benefit to your position.
Paying off debt could be a better use of savings for a risk-free return, but if this was instead invested in a higher performing investment like shares or property, it could compound exponentially over time to a better outcome.
Investing free cashflow over time also reduces market timing risk and can smooth out total return, when invested consistently.
It is important that whatever you choose to invest in, is in line with your risk profile and suited to your investment time frame. This includes consideration around your short, medium and long term needs for the funds.
Invest savings or accumulated capital
If you have accrued capital that is locked away either in bank accounts or home equity, then you should think about investing some of it. Quantifying how much you have and what you are prepared to invest for the future, is the next most important step in securing your retirement.
Decisions about investment of capital are intrinsically tied to the impact they will have on your cashflow, and the considerations explored previously. This means, any investment you make must be made in light of your:
- Free cash flow;
- Goals and objectives;
- Risk profile;
- Identification of which investments are appropriate; and
- Diversification of asset class
Then when it comes to investing capital and choosing which investments are suitable, other important considerations include:
- Time Frame – How many years you have left for investing is absolutely critical to determining which asset classes and/or investments are appropriate. Longer term horizons allow for investment in growth assets like shares and property, whereas shorter time frames require less volatile more defensive investment choices
- Capital buffer – Your free capital is one of your most important risk management tools, for managing unforeseen periods where your cash flow is impacted.
- The power of compounding – Compounding is the 8th wonder of the world, according to Albert Einstein, who famously said “He who understands it, earns it…he who doesn’t…pays it.” What he means, is that assets grow more rapidly overall, the longer they are left invested.
Legally minimise your tax liability
Tax is the biggest expense most of us will have in our life, yet few understand how to structure our finances to reduce it.
There are lots of strategies to legally reduce tax, but you don’t want your tax decisions to drive your investment decisions. Rather you want your investment decisions to be guided by great tax outcomes, that make your money work for you now, next and later down the track.
Strategies can include:
- Superannuation – Highly tax effective and suited to retirement savings
- Structuring like companies and trusts – how you own your assets, is a large determinant of the tax that you will pay
- Negative gearing – borrowing to invest is typically tax deductible
- Debt structuring – maximising tax-deductible debt and reducing non-deductible debt as quickly as possible is fundamental
Structure your debt well
Typically, the second biggest expense after tax that most Australians have in life is the interest they pay to the bank.
Ensuring your debt is structured properly throughout your working life can save hundreds of thousands of dollars over the journey. Just like tax, it can offer a guaranteed rate of return; this time through paying less interest.
Depending on your situation there are a variety of ways to structure your loans to achieve a better net cost of borrowing. Some of these include:
- Negotiate a better interest rate – self explanatory
- Choose flexible lending options – you never know when you will get a lump sum or want to make a change to your lending arrangements, so its preferable to have flexibility in how you manage your debt commitments
- Offset account – one of the best Australian inventions for investors and yet largely not understood for debt management. Offsets are a must for investors that have debt
- Focus on your highest interest rate first – Not always the right thing to do, but always a good place to start, when considering which debt to pay off first
- Use a mortgage broker – a good mortgage broker has access to the market and will help you navigate lender selection and a good one will help with structuring too. At Yield we take a financial planning approach to mortgage structuring, which is what you want to look for
- Generally, avoid going directly to the bank – just remember that no matter how nice or knowledgeable your bank advisor is, they are employed to sell bank product!
Protect your downside
Risk mitigation is equally important to growing wealth. In fact, without effective risk strategies you will almost certainly underperform your potential. In order to protect your downside effectively, you must first be aware of your risks. Let’s explore some:
Health risk – Quite simply, the possibility that you might not be able to work due to illness or injury is possibly the most significant risk you face financially. Your earning potential throughout your life is the biggest asset you have and therefore you cannot afford to not insure it.
Market risk – It’s important to know the market you are investing in; if you are favouring one market over another (we refer to this as ‘taking an asset allocation tilt’), make sure you do it with your eyes open. Market risk is first and foremost about the asset allocation you select. Be aware of your long-term risk comfort before you allocate your funds to particular markets and spread your funds across the asset classes accordingly. In almost all instances, asset allocation will have the most significant impact on end return over time, so it is a crucial factor to keep in mind.
Investment risk – It’s the old adage: don’t put all your eggs in the one basket. Investment risk can be managed through diversification together with careful research before starting. Not all stocks will perform equally and therefore an over-allocation to one or another investment will impact your return, either positively or negatively; thereby increasing your risk.
Employment risk – The risk of losing your job or managing periods of time you choose to be out of the work force, must be considered. At its core, this relates to having a plan to self-insure for a period if this were to occur. A common strategy we employ is to make sure that an adequate buffer of funds is readily available to meet at least short-term income needs. This could be a buffer you maintain in your loan structuring or having cash at bank. The danger of not having this is that you might be forced to sell an asset at an inappropriate time, potentially at a fire sale price and with other flow-on impacts, such as buy and sell costs
Finance risk – There is always a risk that your lender will call in a loan. A less dramatic yet still difficult scenario is not being able to meet your monthly repayment, due to circumstances at the time. The last thing you want to have to do is go to your bank, hat in hand, and ask them for funding when you are at your most vulnerable. A combination of the solutions above will help mitigate this risk, especially having a ‘buffer’ and adequate personal insurance.
Legislative risk – Legislation is constantly shifting, so it is important to keep informed and understand how it impacts your strategy. It’s not always bad – even apparently dire changes can present opportunities. Plan to manage change, through awareness and making considered choices in response.
Losing money through any of these events will impact your chance of achieving a comfortable retirement and depending on the severity, could be calamitous. Protecting downside is simply too important to ignore and requires careful planning to get right.
At Yield our focus is on helping people retire securely. If you are a professional or business owner in your 40’s, 50’s or 60’s, we can assist you to build a bridge to a secure retirement, where you are supported and encouraged to achieve the retirement lifestyle you want.
How prepared do you feel currently to achieve a self-funded retirement?
By James McFall
James is the founding director of Yield Financial Planning. His main roles include chairing the Yield investment committee and leading the business to ensure Yield remains at the forefront of best practice Financial Planning advice in Australia. He holds a Master of Commerce (Financial Planning), Graduate Certificate of Commerce (Financial Planning) and a Diploma of Financial Advising. He is a Certified Financial Planner (CFP®), has a Certificate IV in Property Services (Real Estate), is SMSF accredited and is a passionate advocate of the Financial Planning industry. What James loves most about Financial Planning is the satisfaction of helping our client’s transition to retirement with confidence.
