Author Katrina Shanks, CEO Financial Advice NZ Article originally published in Stuff.co.nz.
In part three of our retirement series, Financial Advice New Zealand chief executive Katrina Shanks looks at the retirement options for a 25-year-old on a salary of $50,000 and how three simple decisions could supercharge your KiwiSaver portfolio.
Most people would have been shocked by the lump sums and weekly savings the 2021 New Zealand Retirement Expenditure Guidelines estimated people would need to live in retirement.
The calculation of a $170,000 lump sum needed for a single person living in the provinces on a No Frills (basic) lifestyle, and the $185 weekly savings needed if starting from age 50 was one thing. But the $809,000 needed by a couple living in a city on a Choices (a few luxuries) lifestyle, and the $917 weekly savings need from age 50 if you are starting from scratch is quite another.
They would have been real wake-up calls for many who have been accused of sleepwalking into retirement.
But there was some good news, and that came in the calculation that the weekly savings required if starting at age 25 would be $47 for the single person and $251 for the couple.
It’s well-acknowledged that saving from an early age is the ideal approach to ensuring you have enough money to be comfortable in later life, and this was further evidence of it. I could talk about the benefits of compounding interest but I won’t as that’s a whole article in itself.
But there are different ways to save, and KiwiSaver is increasingly becoming the go-to platform, particularly among younger people.
Investment adviser firm Consilium has looked at the Retirement Expenditure Guidelines and done an exercise based on the premise that all the money you needed for a good retirement was available via KiwiSaver.
It based its calculations on a 25-year-old investor with zero savings on a $50,000 salary. It used an employee contribution rate of 3 per cent, an employer contribution rate of 3 per cent, wage inflation of 3 per cent per year, the government’s contribution rate of $521, an employer contribution tax of 33 per cent, and a defensive portfolio earning a net return of 1.5 per cent.
Its projection showed a KiwiSaver balance of approximately $282,837 at age 65.
But according to the Retirement Expenditure Guidelines, a single person living a Choices lifestyle in a metropolitan area would need about $600,000 if retiring today.
But that’s today.
Based on an inflation rate of 2 per cent over the 40 years a 25-year-old would be investing till retirement age, Consilium calculates that $600,000 would grow to a target retirement balance of about $1,325,000.
That’s a massive gap, so how to change it?
Consilium says investors starting saving at 25 need to make three key KiwiSaver decisions, and each would have a significant effect on closing that gap:
- How much to save
- What KiwiSaver allocation to use
- When to retire.
How much to save
Most investors put 3 per cent into KiwiSaver to maximise the employer contribution, but they could invest more – 4 per cent, 6 per cent, 8 per cent and 10 per cent are also options.
Increasing the rate to 10 per cent increases the balance at age 65 by 125 per cent. Certainly, well worth doing if you can afford to put that much away, but it’s still not enough for a Choices metro lifestyle.
What allocation to use
Using the Financial Markets Authority’s assumed rates of return for various KiwiSaver return projections after taxes and fees (defensive 1.5 per cent, conservative 2.5 per cent, balanced 3.5 per cent, growth 4.5 per cent and aggressive 5.5 per cent), Consilium calculated the value of those portfolios at age 65 and the increase over default.
The difference was quite astounding.
A defensive fund had a value of $282,837 at age 65 and no impact over default; a conservative had $340,978 and a 21 per cent impact; balanced $415,819 and a 47 per cent impact, growth $512,733 and an 81 per cent impact, and aggressive a value of $638,895 and a 126 per cent impact over default.
What a huge difference ticking a box can make, but it’s still not enough for that Choices lifestyle.
Which brings us to decision three.
When to retire
Consilium also did some work on the impact of working past 65, as is reasonably common, and found this can also have a fairly significant impact on a KiwiSaver balance.
For example, working till 70 increases the projected one-person KiwiSaver value to $353,385 (a 25 per cent impact over default), while working till 75 would give a total of $463,712 (a 54 per cent impact).
Though significant, working longer has less impact than investing more aggressively or saving more.
The biggest relative impact compared to the default is taking more investment risk (a 126 per cent increase over default in an Aggressive fund), followed closely by increasing contributions (125 per cent investing 10 per cent). They both have more than twice the percentage impact compared to working till 75.
But none of them alone gets near the projected target retirement balance of $1,325,000.
What about a combination?
Consilium calculates if the 25-year-old investor saves 10 per cent into an aggressive KiwiSaver fund and works till 75, their portfolio would be a huge $2,736,344 – way more than the $1,325,000 needed under on Massey University guidelines.
So, you could consider easing back on some of these decisions and still achieve the goal.
For example, you could reduce your contribution from 10 per cent to 8 per cent at age 50 and to 6 per cent at age 56 and end up almost right on that $1,325,000 target. You could get the same result if you moved your fund from aggressive to growth at age 60 and then to balanced at 63.
It’s clear these simple decisions can make a massive difference to that lump sum.
And it still doesn’t take into account the differences between KiwiSaver portfolios, or that your earning power will likely increase over that 40-year period as you change jobs or gain promotions etc.
So where to from here is relatively simple: understand your financial goals and needs. That means setting a target for your retirement and the assets you’d like to accumulate along the way, alongside the lifestyle you’d like – remember, your life is about balance.
This will influence your financial behaviour, but more importantly it will make you aware of your outgoings and where you need to make adjustments. If in doubt, contact a professional financial adviser.
It’s just a matter of determination and discipline and starting early.
Katrina Shanks CEO Financial Advice NZ and Ben Brinkerhoff Head of Advice Consilium.