Navigating changes in spending and lifestyle

Navigating changes in spending and lifestyle

Graeme Forster

One of the hardest questions to answer with superannuation is how long it will last.  Estimating how much you will need for retirement relies on many assumptions about investment returns, the amount required to support your standard of living and how to consider unexpected events.  No matter how reasonable or conservative your assumptions may be, the amount you can access may still not be enough to live on.

As a starting point why don’t you write a list of what you expect to happen financially over the next 5 years.  Then cast your mind back over the last 5 years and remember what you expected could happen at the beginning of that time and compare that to what happened.  Has it worked out better than your thought or not as good as expected?   Then, as a sobering thought, think about how long you could be drawing from your super fund and some of the untimely events that may take place.

Let’s have a look at a case study of Nick who is 65 and has retirement savings of just over $1.2 million in his SMSF.  In the first year he has decided to draw a pension which will be tax free of just under $60,000 to live on which will increase each year by the movement in the Consumer Price Index.  The assumptions are that CPI is expected to be 3% p.a. and the long-term earnings rate is estimated at 7% p.a.  You may think these assumptions may be a little high in the current economic environment but don’t forget we are considering a long-term horizon of 20 years of even longer.

Nick has considered some situations that could occur with his retirement savings in future.  These are:

  • he draws down $100,000 as a lump sum at age 75 which will be the 10th year after he has retired,
  • the long-term earnings rate ends up being 5% rather than 7%, and
  • he draws down $300,000 in the 20th year after retiring when he will be 85 years old.

Pension drawdown as expected

If Nick draws down his $60,000 pension at age 65 which is indexed to 3% CPI and the fund earns 7% long-term then it is reasonable to expect that the pension will last him until he is about 98 years old.  That’s the outcome Nick would like as it gives him some confidence that he will sufficient to live on for most of his life.

Here’s what the balance remaining in his SMSF pension account would look like after he has withdrawn the pension each year.

Image 1 - graeme folley

Drop in long-term earnings rates from 7% to 5%

If the earnings on Nick’s superannuation balance was to drop in the long term to 5% then his retirement savings would last him until he was 88.  If he lived beyond that age, he would need to work out his living expenses.  It may also mean cutting back on his lifestyle needs earlier in retirement, so he can stretch his budget that little bit further.  He may need to consider applying for the age pension to supplement his living expenses.

Here’s what Nick’s superannuation balance in his SMSF would look like if the long-term earnings rate was to be 5% rather than 7% as he expects:

Image 2 - graeme folley

Drawing $100,000 in the 10th year after retiring

If Nick needed to drawdown a lump sum of $100,000 in year 10 after retirement, in addition to his pension, the amount he has in his SMSF would last him until about age 95.  While his superannuation savings may not last if if he kept to just drawing the pension and his savings earned 7% long term it is still a better result than if long term earnings dropped significantly to 5%.

Here’s Nick’s superannuation balance after withdrawal of the $100,000 lump sum in year 10 and the fund earning 7% long term:

image 3 - graeme folley

Drawing $300,000 in the 20th year after retiring

If Nick required a lump sum of $300,000 in the 20th year after retiring when he was 85 his superannuation savings would last him until he was about 95 years old.  This shows the effect of compounding earnings and the later lump sums are withdrawn the more favourable the result.

image 4 - graeme folley

Lessons to be Learnt for Nick

The main thing Nick needs to keep an eye on is the long-term earnings rate for his SMSF.  This may require rebalancing the fund’s portfolio to ensure volatility in the fund’s investments is managed as best as possible.  If there is a drop in the long-term earnings it may mean taking greater investment risk if he wishes to maintain his expected spending pattern or maintaining the same investment mix but tightening his spending to be in line with the lower expected returns.

If Nick ends up requiring lump sums to be withdrawn from his SMSF it is probably a better result if they were withdrawn the older he is.  However, this may be difficult to control and predict as the withdrawal may be required for health or other essential spending with may arise without warning.

Navigating changes in spending can be a challenge for all of us but the main thing is to keep something in store for that ‘rainy day’, whatever it looks like, so you can handle the bumps in the road during retirement.


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