How does the idea of having more money in retirement sound?

The good news is that anyone can build their retirement funds. The bad news is that not many people seem to be taking advantage of the opportunity.

Luckily, both you the reader and we at HisHerMoneyGuide are pursuing financial independence, and in particular early retirement, so it's a topic dear to our hearts.

Most people in the Australian context will depend on superannuation to fund the bulk of their retirement. However, superannuation can be an overlooked opportunity in the FIRE equation, or alternatively something that can be dangerously relied on.

So what role can it play in FIRE planning, and what are our own plans for superannuation when we retire?

Firstly, let’s start with a brief recap on the purpose of superannuation in Australia. Currently, employers are legislated to pay 9.5% of staff wages into their employees’ retirement funds in most instances. That’s due to rise to 12% by 2025.

For the most part, as long as you receive at least $450 a month in wages from your employer, you should receive superannuation into your nominated account. Some superannuation fund managers perform better than others, so it's very important to shop around.

Why does superannuation exist? Rather than governments needing to pay pensions, it was decided that people should have their wages set aside for them - compulsory retirement savings – so as to take pressure off the public purse. It's a multi-decade goal, and so far it's resulted in almost $3 trillion in retirement savings as at December 2019.

If you consider the finances of an average household, it's a simple fact that many people need money set aside for them automatically, because otherwise they'd spend it on their day-to-day living expenses and luxuries. It's financial FOMO and YOLO rolled into one. People generally don't plan for things decades into the future, but that's what sets people who pursue FIRE apart from the others (though we share a love of four-letter acronyms).

So how do the finances of superannuation stack up for retirement?

Figure 1: The $50,000 income is arbitrary, but we know which income option we'd choose, and which one we'd avoid at all costs. Needing to access the age pension would be a drastic decrease in income. Lesson: don’t run out of money in retirement!

It's important to understand superannuation and how to factor it into your FIRE journey. That's why this chapter will extensively go over some helpful topics, such as:

• Retirement expenses: what superannuation tells us you need
• How much superannuation do you need?
• Superannuation and FIRE - a much needed safety net
• Superannuation in the background: An opportunity
• Don't rely on your superannuation

Retirement expenses: what superannuation tells us you need

If you go hunting for numbers for superannuation planning, you'll see that each fund has slightly different numbers compared to others, but the numbers generally agree with each other.

If you're an Australian couple retiring at age 67, it’s estimated that you need about $62,000 a year to live a comfortable retirement – and about $45,000 a year for a single person. That comfortable life will allow you things like an overseas holiday every year or two, plus good health insurance.

A more modest retirement will still cost you about $40,000 for a couple and $28,000 for a single per year. It's not a poor life, but you'll rarely have any extravagances, and depending on your post-work goals, values and interests, that can be enough (think of it pretty much as being a LeanFIRE lifestyle).

In comparison, the Australian government aged pension currently pays about $32,000 a year for couples and $22,000 a year for singles. Being on the aged pension will allow you to survive, but sometimes not much more than that. It’s a frugal life by necessity, without much support for extra costs such as healthcare, home maintenance, holidays or other little luxuries such as a night out.

At this stage, you might be wondering what any of this has to do with FIRE.

Well, you might be retiring well before the age of 67. But even if that’s not the case, superannuation still has some teachings for you, and it's also an opportunity to both improve your FIRE finances and increase your financial safety net.

How much superannuation do you need?

Firstly, what sort of superannuation balance do you realistically need in order to achieve the numbers outlined above? The Industry Super Funds retirement calculator says that to achieve a ‘comfortable’ lifestyle, you need to have a balance of $1.1 million as a couple and $780,000 as a single.

For a more ‘modest’ retirement lifestyle, you’ll need $720,000 as a couple and $500,000 as a single.

Pretty big numbers, right? Well, it's nothing too extreme (after all, people retiring at age 67 would have been working for well over four decades at that stage, so there is plenty of time to build up those balances).

But here's the kicker.

Those numbers are for you to retire at age 67 and only live to age 85 - the approximate average life expectancy right now. That's only 18 years of retirement.

If you decide to (in our opinion, wisely) play it safer and adjust your life expectancy by an extra decade to 95 years, it's recommended that you need to increase those sums by around 50%. Ouch.

Maybe we've telegraphed our lesson here too much, but there's an important learning amongst all of these numbers. The goal with superannuation is to essentially use it all up. It's not a perpetual money-making machine. In the latter retirement case, $720,000 is only enough for a couple to live modestly for 18 years, while they'd need about $1,080,000 to support themselves for 28 years.

We've previously expressed our concerns about LeanFIRE, so hopefully those numbers give you some pause for thought if you're planning to retire 20 or 30 years ahead of the usual retirement age.

Meanwhile, superannuation has much higher withdrawal rates than the widely cited 4% withdrawal rule - and that's based around a 30-year retirement.

So for my money, that suggests that you need even more money to make your investment portfolios stretch for half a century (give or take), let alone taking into account the possibility of large expenses in retirement, such as growing healthcare costs.

Figure 2: Running out of money early. (Assumption: 7% return and 2% inflation on a $750,000 balance and $50,000 in annual expenses.) Portfolio expended at age 63. This is followed by accessing superannuation at age 63 (Assumption: $200,000 into super at retirement age of 35, accessed 28 years later with a value of $450,000.) Your money is effectively expended at age 74. An awful situation to find yourself in if you then need to rely on the pension (see Figure 1 of this chapter).

Superannuation and FIRE - a much needed safety net

At HisHerMoneyGuide.com, we view our superannuation as a safety net – it’s essentially something we're not planning to use if we can avoid it.

We're aiming to retire by the age of 45 with an annual pre-tax income of around $150,000 – earned primarily through a combination of share dividends and rental property income for diversification purposes.

Our goal is to avoid drawing down on any of our capital. We're planning to rely solely on dividends and rent, as opposed to passive income and gradually chipping away at our capital base over time.

Although our approach isn't novel, it isn't favoured by the FIRE community either. Why is that, you ask? Because it requires you to work longer and/or harder in order to build up a larger capital base to begin with. But in our opinion, it's by far the safest approach.

We're being very careful about planning for a savings and investment portfolio with in-built redundancy. Essentially, our long-term goal is that the superannuation we’ve accumulated won't ever be needed. Our investment portfolios will hopefully continue to grow over the years, in terms of both dividends and capital values for perpetuity (eg. forever).

However, what if this grand plan doesn’t play out as expected?

What happens if some of our investments fall over, losing us dividend income? What if our income doesn't grow enough to match inflation? What if our expenses outpace any inflation and income growth due to a reason such as illness as we age? Or what if we encounter other unforeseen expenses later in life?

This is precisely why we’re aiming to play it safe. We strongly believe that anyone who pursues FIRE should actively plan for a realistic worst-case scenario.

At the time of writing, coronavirus is basically a real world example of that worst-case scenario in action. Dividends are dropping across the board, share values have fallen, and many tenants have lost their jobs – subsequently passing on financial stress to their landlords.

In our case, we're yet to see how bad the impact will be. But we're expecting our passive income to drop by a good 50%. This obviously isn’t great news. However, if you take a quick look at our retirement budget, you'll see that we could realistically survive income drops of 66-75% without needing to dip into any other money such as cash savings or drawing on our capital base.

It's eventualities such as these (i.e. short term shocks, or longer term erosion of wealth) where we can envision that superannuation might become our safety net.

The good news is that anyone who has worked in Australia before their retirement should have some level of superannuation tucked away for a rainy day. The even better news that this money will be there even if it’s not needed, and that could actually make retirement very tasty indeed.

Figure 3: Example of a portfolio drawdown from age 35 with a safe balance to avoid pension: (Assumption: $1,500,000 portfolio, 7% return, 2% inflation, and $50,000 in annual expenses.) Unless you're retiring as a teenager, you should be fine under this scenario!

Figure 4: Thanks to a higher initial amount and compounding, you can beat the value of the pension (accessed from age 67) over time and have an increasingly higher quality of life than future pensioners.

Superannuation in the background: An opportunity

As great as superannuation is, there is one big downside. Under current Australian government laws, you cannot access your superannuation balance until you’ve reached the age of 60. For Australians looking to FIRE, this can pose a significant problem.

In our case, it'll be at least 15 years post-retirement (at age 45) before we can access that money. It's for that exact reason that we're not contributing any extra money into our super accounts right now, even if it is currently the most tax-effective thing to do.

In fact, we used to contribute extra into our superannuation for that very reason but stopped years ago because we firmed up our early retirement plans, and saw the giant gap between the time we locked that money away and when we'd be able to access it.

Nevertheless, the good thing is that once we do retire early, we'll have a nice super balance that will no longer be receiving any contributions but will still be growing quietly in the background.

Personally, our goal is to accumulate a superannuation balance of around $700,000 between us at the time of pulling the pin on paid employment.

Recently, our superannuation funds have yielded an annual investment return of around 9-10% per annum (around 6-7% above modern inflation). However, it’s also worth keeping in mind that the 100-year share market return in Australia is actually only 2% per annum above inflation (with a total increase of 6% – so that’s historically 4% annual inflation), so it's worth considering longer term trends to factor in the possibilities.

In our case, if our superannuation outperformed inflation by 6% per annum, it would grow from $700,000 to $1,677,000 over 15 years. Alternatively, if it only outperformed inflation by 2% per annum, our super would grow to $942,000 by the time we'd be able to access it. Both of those amounts are effectively 'in today's money' (after stripping out inflation).

You can draw down 4% of your superannuation at age 60, so that would end up being an extra income (after tax) of between $37,000 and $67,000 per annum (depending on a 2-6% net return).

Those are some eye-watering numbers right there folks. For us, that would be some heavy icing on the early retirement cake, considering that our $150,000 gross income would be around $115,000 after tax. So by dipping into our super, we could access extra available funds of somewhere between 32-58%. Crazy.

However, if we face any extra big annual expenses (such as medical bills, home maintenance costs, or even just needing extra help around the house with cleaning, gardening or wanting to order in more cooked meals to cut back our physical workloads as we age), that sort of money should cover these additional costs, while still allowing us to maintain our previous lifestyles and expenses. In late life, that's also enough money to open up options such as qualified in-home care.

Alternatively, if our income does gradually erode over time (or a combination of increased expenses and decreased income), unlocking our superannuation will also cover such an eventuality.

But if we hit the age of 60 and things are still going well, with our investments performing as expected, then that superannuation money is just sugar on the top. It could fund all sorts of extra comforts, interests and hobbies.

We reckon that makes superannuation a remarkable all-in-one financial safety net and opportunity.

Figure 5: $50,000 annual expenses (2% inflation adjusted). As an extension to the depletion of money scenario (figure 2 of this chapter) that ran out of money at age 63, if you have a higher (safer) initial balance you can then see the additional safety net provided by superannuation once it is accessed at the same age.

Don't rely on your superannuation

Everyone's financial goals are unique because we all have different incomes, different expenses, and different things that we want to do with our money.

So our example is highly relevant to us, but perhaps less so to you.

Nevertheless, we hope that if this chapter has conveyed anything at all to you, it's that you should build a resilient financial safety net that can withstand multiple hits in the future.

In our opinion, superannuation is about as good a safety net as you can get, because it'll always be there bubbling away in the background to a greater or lesser extent, and you can't access it for a number of years.

However, because it’s critically important to build redundancy into a financial portfolio (and redundancy is just another level of diversification), you shouldn't rely solely on superannuation to fund your retirement.

If you're planning to retire early and use a strategy that draws down and depletes your core investment capital by the age of 60 or so, and then access your superannuation to fund the rest of your life, this ultimately means that your portfolio has one less level of resilience.

If you ever find yourself relying on just one income stream, that's no longer true financial independence. Instead, it's just one step away from dependence. You could easily find yourself just one big expense away from depleting it and relying on government support.

Even worse, let’s say you retire as a couple at age 35 with a $200,000 superannuation balance (which is above average for that age) and you’re planning to depend on accessing those funds at age 60, it might grow to $850,000 with a 6% net (after inflation) return over the next 25 years.

Or it might only grow at the historical 2% post-inflation rate and be worth $320,000 'in today's money' at age 60. At that level, you'll only have around half the income required for a "modest" lifestyle, and you’d be better off on the aged pension (if it'll exist at all in around 30 years).

We admit our own Fat/HIFIRE early retirement lifestyle might be overkill for most people. However, we want the reassurance and comfort of knowing that we never have to work again and have the freedom to pursue our own passions and interests – all the while being able to protect and maintain our lifestyles in all but the most extreme circumstances. The alternative scenario presents the risk of needing to return to work (maybe at a time when we're literally unable to work because of an economic downturn or ill health), which would be a major disruption to our lifestyles and everything that we've worked so hard to achieve.

Therefore, even if you’re only striving for a humble early retirement, you should build a similar number of protective layers into your own retirement plans, at a level that is proportionate to your financial goals.

Superannuation might not be the financial hull of our ship, but it's a safety rail that we know we can fall back on to protect us from other ravages that could threaten the viability of our FIRE goals.

About Alex and Ellie from HisHerMoneyGuide | hishermoneyguide.com

Alex and Ellie live in Brisbane, are in their mid-30s and looking to Fat/HIFIRE by the age of 45. HisHerMoneyGuide.com follows their journey to an early retirement lifestyle where money isn't an obstacle to reaching their goals of a beachfront retirement and months of international travel each year. They've been blogging since 2019 and have a current net wealth of over $2 million. They’ve set themselves a FIRE target of $4.3 million, with a $150,000 per annum passive income.

NOTE: Aussie FIRE is a free educational resource prepared by Pearler, with permission from the co-authors. At Pearler, we strive to make investing for your long term goals easier and fun, but we only provide general information and/or general advice. We don’t present you any options based on your personal objectives, circumstances, or financial needs. Any advice is of a general nature only. All investments carry risk. Before making any investment decision, please consider if it’s right for you and seek appropriate taxation and legal advice. Please view our Financial Services Guide before deciding to use or invest on Pearler.