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Saturday, 11 February 2017

The retirement income myth

Something that endlessly frustrates me about commercial financial planners and retirement gurus is the dodgy maths that they pull. It goes something like this:

"Hello! Welcome! How many of you are prepared for retirement? Did you know that if your combined household income is $100,000, then your after tax pay is roughly $85,000. Do you know how big your investment portfolio needs to be to support an $85,000 income? At least $2 MILLION!! Now let me do some quick maths to show you how you could never save your way to $2 million and you need my special product I'm selling!"

bzzzt, wait, hang on, back that up a second.

These retirement gurus are running a basic calculation that looks something like this:
Current Household Salary minus Annual Tax equals Required Retirement Income 

Let's poke some obvious holes in this with two concepts, savings, and pay rises.


The first and most obvious is savings. It turns your equation into this:

Current Household Salary minus Annual Tax minus After Tax Savings/Investments equals Required Retirement Income

These retirement gurus tell you that you need $85k income in your retirement. They then tell you that if you put aside $20-30k a year into their investment program, you'll be able to achieve that $85k income in 10-15 years.

Now, hang on a second, riddle me this. I earn $85k a year and I invest $30k, then I must be living comfortably on the other $55k. I then retire and I'm making $85k a year, and I no longer need to push money into my investments. What am I supposed to do with that extra $30k a year? That money will pay for a super fancy round the world trip in year one. I buy a couple of jetskis in year two. In year three I might pay a friends medical bills. Year four I decide to buy a racehorse.... I mean, there are things I could do with an extra 30k (55% more money than I've ever spent in a year!) but how many of those things are worth the extra years I spent at work to get here? Paying my friends medical bills would be. A round the world trip would be lovely, but there are so many people out there doing it on $10 a day, I don't think I would need ten times that amount on top of my already pretty nice income.

If you're sitting across from a retirement planner and they're talking about replacing your income and he/she doesn't consider that difference between you're living costs and your savings, you should be raising an eyebrow so high you get a muscle cramp in your face. Then maybe run. Or be less dramatic and take their advice with a hefty pinch of salt.

Getting a payrise

Say we believe the retirement guru, we need to replace our entire after-tax income. This is the be all and end all goal. Well then there is a slight problem with getting a pay rise. This becomes really obvious when you plug some values into the equation:

Current Household Salary minus Annual Tax equals Required Retirement Income
$100,000 minus $15,594 equals $84,406
Required portfolio (at 4%) = $2.1million

But then you've been working really hard, pick up a $20,000 p/a payrise and suddenly the equation looks like this.

Current Household Salary minus Annual Tax equals Required Retirement Income
$120,000 minus $22,094 equals $97,906
Required portfolio (at 4%) = $2.4million

Hang on a second. I'm earning more money, and now I'm further from retirement? How does that work? Well if I was spending 100% of my income on living and not saving a cent, then it would. If I took my $20k pay rise and matched it with a bad habit of going to the races and throwing it all away on the long odds horses who never won (because I have the worlds worst luck) then sure, now I need more to retire on to support this habit.

But if I'm already actively considering my retirement, then I'm not going to blow my $20k pay rise and push my retirement further away. I personally would take a little but for myself (maybe $2k a year) and throw the rest a bringing my retirement date closer. Obviously this all depends on your circumstances. If you were struggling to stay above water you might need to take $5-$10k to have a comfortable life. If you were already thrilled with your life you might throw the whole lot towards retirement. But just because you are earning more now, doesn't mean you need more in retirement.

Putting it together

I'm not going to say throw the baby out with the bathwater. Most financial planners aren't vindictively trying to hold on to you for longer. Some are and you should run very fast and very far. Some just don't differentiate between your income and your expenses. They are probably the kind of people who think that more money would make them happier. They might have higher expenses than you. I sat at a conference yesterday where the presenter outlined a portfolio that would return $160k p/a in ten years, and then said "Hmmm, $160k, that's not much is it" and everyone agreed! $160k would pay for my lifestyle three or four times over! 

This doesn't mean I'm going to completely reject his advice on how to get that $160k portfolio. But I would be completely satisfied with half that amount. This doesn't make his advice wrong, it just means I need to tailor it to my situation. He then went on to show how to use that portfolio to create an income of $250k p/a. Not sure how many jetskis and racehorses this guy is planning to buy, but I'll be content with getting my free time back, retiring early and alternating between taking long holidays and chilling out at home with my cat. 


  1. Wow $250k per year? I can't even imagine what sort of lifestyle that would afford.
    Something else to consider above your current savings is how much you are putting towards your mortgage each month if you have one. Once that is gone there is usually 20-30% extra money so it is likely you'll need even less in retirement.
    Right now I'm comfortably spending $30k/ annum. This will increase with marriage, mortgage and midgets, but in future with a paid off house and an empty nest, I could easily slip back into this, considering inflation along the way.
    Hopefully I stumble across $250k and can pay for 8 years of my lifestyle��

    1. There's an add on spotify right now offering to win $20k a month for the rest of your life - imagine that madness! I'd pour most of it into charity because I wouldn't know what to do with it all.

      As for mortgages, I have a post in draft about that. But to put the idea into your head - my mortgage charges 4%, my investments make 7%. Why pay off a 4% debt if it's going to mean I miss out on a 7% investment?

  2. Whilst I agree with a lot of what you have said, there is still slight hole in your argument. Regardless of what your annual income and expenses are.
    What is this hole? Well you do have to equate some savings into your annual expenses to calculate what you require for retirement; rather than income minutes expenses. Why? Because you still need to factor in one off emergency purchases. For example: if your car blew up or your fridge broke down when you have retired, you need the $$$ to replace.
    Hence, rather than say it's simply a matter of income minus expenses gives you your retirement figure it is income minus expenses plus one off purchases.
    Whilst we don't have a crystal ball when it comes to one off expenses, we do have to polish it and project what it could potentially cost to replace essential items we require for retirement.
    Penny for your thoughts

    1. This is why I calculate mine over five years, instead of just the one :) Five years for me includes a knee reconstruction, moving house, a new airconditioner, new hot water system, painting a house... plenty of 'one offs'


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