How much do you need to save for retirement?
The obvious answer is it depends. We all have different circumstances and factors like having a paid off house or the type of lifestyle each of us desires in retirement will influence how much we need to save.
Consider Other Income Sources: It also matters if there are other potential sources of retirement income, such as the New Zealand Superannuation. The current NZ Super rates are $538.42 net per week for a single person living alone, and $414.17 per week each for a couple who both qualify.
Income Replacement Rule: A common rule of thumb is that retirees should be able to replace 70% of their income in retirement. Let's use that figure as a starting point and assume that you can also rely on NZ Super.
Factors Influencing Your Nest Egg: Several factors influence the size of your retirement nest egg. The amount you save is crucial, which is the factor we will explore today. It also matters how high of a return you receive and the amount of time you have to save and invest.
Hypothetical Saver Profile: Let's assume our saver is 35 years old and employed. They have a $100,000 salary. Their KiwiSaver contributions are 4% p.a., and their employer's contributions are also 4%. This saver has used their KiwiSaver for their first home deposit and therefore is starting off with a KiwiSaver balance of $1,000. They will spend 30 years in the workforce before retiring, with wages increasing at a 3.5% annual rate to keep up with inflation
Baseline Assumptions: As a baseline, I will use the sorted.org KiwiSaver Growth fund assumed rates of return of 4.5% p.a. (after tax at 28%). I will assume that same return is earned over the entire working life of our hypothetical retirement saver. We will explore the impact of different levels of return later. Inflation is assumed at 2.5%.
Scenario Analysis:
Current Savings Rate: Our hypothetical retirement saver was able to save $360,000 (adjusted for inflation). With NZ Super, they could draw an income close to $870 per week in retirement, which is $476 per week short of their desired income. This isn’t a great outcome.
Increased Savings Rate: If they increase their personal savings contributions to 10% of their salary, our hypothetical retirement saver could save $677,000. With NZ Super, they could draw an income close to $1,162 per week in retirement, which is $184 per week short of their desired income. Much better but still slightly off their income goal.
Higher Returns Scenario: What if returns are higher? Our hypothetical retirement saver has invested in a high-growth option. Using the Aggressive fund assumed return of 5.5% p.a. (after tax). All other assumptions remain the same.
Impact of Higher Returns: You may think that a return of 1% more a year isn’t a lot. However, over the long term, even small differences in returns can make a big difference. That is why it is so important to focus on anything that detracts from returns – fees, transaction costs, and taxes, to name just a few.
Current Savings Rate with Higher Returns: In this case, our hypothetical retirement saver was able to save $420,000. With NZ Super, they could draw an income close to $925 per week, which is $421 per week short of their desired income.
Increased Savings Rate with Higher Returns: Increasing their personal savings contributions to 10% of their salary, our hypothetical retirement saver could save $789,000. With NZ Super, they could draw an income close to $1,296 per week, which is only $50 per week short of their desired income.
Key Takeaways:
Savings and Asset Allocation: Both the amount you save and how you allocate your assets are critical to achieving your retirement goals.
Control What You Can: Focus on saving more and minimizing factors that detract from your returns.
Final thoughts
My own personal perspective is that to have a comfortable retirement you should save between 10%-15% of your paycheck when you are young.
You don’t buy insurance because you expect to get in a car accident or have your house burn down. You buy it to protect against the unknowns. Saving and investing also protects against the unknowns – however, unlike insurance there is a pay-off if the risks don’t come to fruition.
If you save and invest a little more than the bare minimum you get to keep and spend anything extra later in life. Seems like a sensible choice with minimal downside.
