Retirement

How to factor changes in spending and lifecycle into managing your SMSF

By Graeme Colley
Executive Manager, SMSF Technical and Private Wealth, SuperConcepts Sydney, Australia

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

As a starting point, try writing a list of what you expect to happen financially over the next five years. Then cast your mind back over the last five 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 you 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 in the future.

Consider Nick

As an illustration, let’s consider a case study. Nick 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. This amount will increase each year in line with movements in the Consumer Price Index (CPI). The assumptions are that CPI will increase by 3% p.a. and the long-term earnings rate is estimated at 7% p.a. You may think these assumptions seem a little high in the current economic environment but don’t forget we are considering a long-term horizon of 20 years or even longer.

Nick has factored in some situations that could affect his retirement savings in future. These are:

  • That the long-term earnings rate ends up being 5% rather than 7%.
  • That at age 75 – the 10th year after he retired – he draws down $100,000 as a lump sum. 
  • That he draws down $300,000 in his 20th year post-retirement, when he is 85 years old.

We explore these different scenarios below.

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 have a sufficient amount to live on for most of his life.

Using those parametres, here’s what the balance remaining in his SMSF pension account would look like after he has withdrawn his pension each year.

Minimum pension 7% earnings

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

If the earnings on Nick’s superannuation balance were to drop in the long term to 5% then his retirement savings would instead only last him until age 88. If he were to live beyond that age, he would need to consider how he would fund his living expenses.

It may mean cutting back on his lifestyle choices earlier in retirement, so he can stretch his budget that little bit further. He may also need to consider applying for the age pension to supplement his living expenses.

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

Minimum pension 5% earnings

Drawing down $100,000 in the 10th year after retirement

If Nick draws down a lump sum of $100,000 ten years after retirement, in addition to his annual pension, the amount he has in his SMSF would last him until about age 95.

While his superannuation savings would not last as long as if he just drew down the pension and his savings earned 7% long term, this still produces a better result than if the long-term earnings rate dropped to 5%.

Here’s Nick’s superannuation balance with a withdrawal of a $100,000 lump sum in year 10 and a 7% long term earnings rate:
 

Minimum pension, $100,000 withdrawal  in year 10

Drawing down $300,000 in the 20th year after retirement

If Nick required a lump sum of $300,000 at age 85, in the 20th year after retiring, his superannuation savings would still last him until he was about 95 years old.

This illustrates the effect of compounding earnings; the later the lump sum is withdrawn the more favourable the result.
 

Minimum pension, $300,000 withdrawal  in year 20

Lessons to be learnt from 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 investment volatility is well managed.

If there were a drop in long-term earnings it may mean taking greater investment risk if he wishes to maintain his expected spending and lifestyle, or alternatively if he wanted to maintain the same investment mix and not increase his risk he could rein in 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 the older his is when they are withdrawn. However, this may be difficult to control and predict as the withdrawal may be required for health or other essential spending which 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 that could arise during retirement.

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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

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