Developing a retirement income budget
To successfully plan your financial future, start by doing a stocktake of your current position.
This involves documenting your current assets and debts. It also involves working out a
budget of expenses, so that you can clearly see how much income you need to meet essential
living expenses and optional expenses.
A simple worksheet for documenting your financial position and your income needs follows.
Take time to complete this as it will make your planning so much easier.
Calculation of your Net Worth
Your Assets
$ Value
Home
Car
House contents
Jewellery and other valuables
Investment property
Shares
Investments in managed funds
Bank, Building Society or Credit Union accounts
Term deposits
Government bonds
Superannuation benefits
Payment for unused annual leave
Payment for unused long service leave
Insurance policies Other
Total Assets (A)
Your Debts
Home mortgage
Car loan
Home improvement loan
Personal loan for other purposes
Credit card balance
Store charge accounts
Investment property loan
Taxation owing
Other
$ Value
Total Debts (B)
Your Net Worth (A-B)
Your Income Stream Budget
Weekly Living
$ per
Other Expenses
Expenses
week
Food Council rates
Council rates
Clothing Water rates
Water rates
Entertainment
Petrol
Car registration
Car insurance
Fares
Gifts
Telephone
Electricity
Donations
Education costs
Gas
Gardening
Rent
House maintenance
Health insurance
Medical expenses
Travel costs
Life insurance
Chemist
Newspapers and
magazines
Hobbies
Mortgage expenses
Other loan expenses
Other
Total Weekly
Expenses
Multiply by 52
Annual Living Costs
(C)
Other
$ per
annum
Membership fees
Total Other
Expenses (D)
If you add columns C and D together you will have your annual income stream budget. This
budget may vary a little from year to year as your circumstances and needs change. Retain
this version, so you can simply review it and update it from year to year.
Now that you have worked out your essential living expenses, prepare a short list of the items
of expenditure that are not essential, but which you would like to do or feel you will have to
do, either now or at some time over the next few years.
Optional Expenditure or Capital items
Your Optional Expenditure
$ Value
Total Optional Expenditure
Armed with your 'financial stocktake', we can now move on to resolving some of the other
key financial questions.
How long will you need an income stream for?
It would make planning our finances so much easier if we knew exactly how long we were
going to live. So how can we estimate how long we need our money to last?
The best way is to work from average life expectancies. The Government produces details of
average life expectancies based on historical information. These are updated from time to
time, and the good news is that average life expectancies are getting longer. While this is
great news in one sense, it also means that our retirement money generally needs to last
longer.
A selection of the average life expectancy factors are shown in
the following table:
Age
Male
Female
55
25.92
29.91
56
25.05
29.00
57
24.19
28.10
58
23.34
27.21
59
22.49
26.32
60
21.66
25.44
61
20.84
24.57
62
20.04
23.71
63
19.24
22.85
64
18.46
22.00
65
17.70
21.15
66
16.95
20.32
67
16.21
19.49
68
15.48
18.67
69
14.78
17.87
70
14.08
17.08
71
13.41
16.29
72
12.75
15.53
73
12.11
14.78
74
11.50
14.05
75
10.90
13.33
76
10.32
12.63
77
9.77
11.94
78
9.24
11.27
79
8.73
10.61
80
8.24
9.98
81
82
83
84
85
86
7.77
7.32
6.89
6.48
6.11
5.77
9.38
8.81
8.27
7.76
7.28
6.83
Australian Life Tables, 2000-2002, Government Actuary
By way of example, a male and female who are both age 65, would be expected to live over
17 and 21 years respectively. Life expectancies in 5 to 10 years time may be significantly
longer, but this should provide some guide for planning your income stream needs into the
future.
Will your needs change?
There is a very high probability that your financial needs will change over time. It is very
unlikely that you will need the same amount of income over a long period of time for a
variety of reasons:
Inflation - while Australia has been experiencing comparatively low levels of inflation for a
number of years, there is still some inflation and there is always the possibility that it could
increase. Inflation is an important factor to consider, and some income streams allow you to
select an indexation option, where your income level increases with movements in the
Consumer Price Index. Alternatively you can have it indexed by a certain percentage each
year. For example, you could have your income increased by 3% per annum, to cope with
increasing costs.
Spending changes - at various stages in retirement our income needs will change simply
because our spending patterns change. This might include specific holiday costs which may
not be part of our normal budget. There may be other items of expenditure such as house
maintenance costs which are unforeseen. There are lots of reasons why our income needs will
change from time to time.
Capital needs - similarly the need to have access to capital may change over time. There is a
strong chance that at some stage in retirement there will be issues such as major car repairs,
upgrading a car or moving house to deal with. There may also be significant costs later in life
associated with health matters, nursing care and using other services as we become less
capable of doing all the things we used to do. Having access to money for key larger items of
expense is sound planning.
As such it is necessary to consider these aspects when you invest in an income stream. If you
refer to the detailed information on the different types of income streams you will be able to
see that these needs can be catered for in different ways.
How long will your money last?
This is the big question. How long your retirement savings will last depends on many things.
If you decide to invest money in a lifetime income stream you will know that the income will
continue for life. So it is not a case of how long it will last but rather, will the income you
receive be enough? You should consider whether or not you will be entitled to any age
pension or social security allowance, and any other investment or employment income you
may receive. We examine the age pension issue in more detail later.
Where you invest in an income stream which is payable for a fixed number of years you have
the comfort of knowing that the income payments will continue for the period of years you
select.
With an account based income stream, your income payments stop when your investment
account runs out. So the key with these type of income streams is to maximise the investment
return on your account to make your money last longer. This doesn't mean that you should
take big risks with your investments - it's just that the better you manage your money, the
longer it will be able to provide you with an income.
We'll look at this issue in more depth later, but consider the following example.
in Real life...
Charlie and Grace invested $150,000 in an account based income
stream. When they chose the fund they were given some
investment choices. They were both aged 64 and knew that their
average life expectancies were over 18 and 22 years respectively.
They were both enjoying good health and they decided that they
should think of this as a very long term investment. They chose
the 'Managed' option, which meant that indirectly they had about
50% of their money invested in the share and property markets.
Over the 20 years, they were able to earn 7% per annum on their
money. When they first invested in the account based income
stream, they needed to draw $10,000 of income per annum. Each
year they increased their income payments by 3% per annum.
With this level of income payments and the 7% per annum
investment earnings their money lasted for 24 years.
*Note that in this example we assume that the investment
earnings rate is the same for each of the 24 years. This is
unlikely to occur as investment earnings will vary from year to
year.
The following table provides you with some idea about how long your money will last. The
table shows different investment earning rates, ranging from 4% to 8% per annum. The table
also shows the level of income that may be drawn, expressed as a percentage of the starting
capital. In each case these income figures are assumed to increase each year with inflation,
which is assumed to be 3% per annum.
To help you use this table - consider 6% per annum investment earnings and an income rate
which is also 6%. This means in the first year, your investment account would remain
constant, because the money coming out of the account is the same as the earnings. In the
second year, the income payments go up by 3% and as such the investment account balance
will start to reduce. The table shows that the investment account will be exhausted after 25
years.
The table is designed as a guide only to how long your money may last and does not
represent an actual allocated pension or allocated annuity account. Later on there is an actual
example of an account based pension.
Table showing the number of years savings will last in an
Account Based Income Stream
Income
Investment
Investment
Investment
Payment Earnings - 4% Earnings -6% Earnings - 8%
Level (% of
per annum
per annum
per annum
Capital)
5%
24 years
32 years
35+ years
6%
19 years
25 years
35 years
7%
16 years
20 years
27 years
8%
14 years
17 years
21 years
In the above table it is assumed for simplicity that income payments are drawn annually in
arrears and that investment earnings are added to the account annually in arrears also. The
investment earnings are net of any fees which may be charged. The income levels do not take
into account the minimum payments each year that may apply for an account based income
stream. This means that the actual income from an allocated pension or allocated annuity may
vary from that calculated in the above table.
Other income sources
How long your money will last depends on many things, as can be seen from the above
example. The impact of income from other sources will be very important. If for example,
you earn some money from part-time employment in your early retirement years, you will be
able to keep more of your capital intact, or perhaps actually build on it for a while.
If you are entitled to a full or part age pension then this will assist in providing for your
income needs. If you are entitled to a part age pension, you may not need to draw down your
retirement capital as quickly and be able to spread your retirement savings out over a longer
time frame.