How Much Superannuation is Needed to Have a Comfortable or Modest Retirement?

ZILI ZHU AND THOMAS SNEDDON, CSIRO

24 November 2015

At this stage, there has been no consensus on the minimum superannuation amount required for retirees to maintain a reasonable living standard throughout retirement. An unambiguous target is important as it can help inform individuals as well as the government when it is setting superannuation contributions rates. Using CSIRO retirement income modelling, this study calculates the minimum superannuation fund balance that is needed to maintain a comfortable or modest retirement lifestyle.

The calculated minimum required superannuation amounts generated by the CSIRO SUPA model are of the same order of magnitude as the often-quoted $1m required for a comfortable retirement lifestyle. However, if a lower probability of success is accepted, the minimum superannuation amounts are much smaller. For example, if 80 per cent is accepted as the probability of success, the minimum superannuation savings level required is $676,000. This paper provides a range of the required superannuation balance levels for given probabilities of success.

The SUPA model is calibrated using certain economic variables and mortality data for the 1993 to 2015 period from the Australian Bureau of Statistics and Thomson Reuters Datastream. The model simulates future scenarios for the co-dependent seven major variables on the Australian economy that are relevant to superannuation: (1) price inflation; (2) wage inflation; (3) Australian stock market returns; (4) international stock market returns; (5) Australian bond returns; (6) international bond returns; and (7) Australian cash investment returns.

In calculating the required minimum superannuation amount for a certain living standard during retirement, the following assumptions are made:

The retirement age of the individual is assumed to be 65 years old. The current government pension system’s effect on the individual’s retirement income is included in the modelling when calculating withdrawals from the superannuation account for maintaining the chosen living standard during retirement.

Individual mortality is projected using the Lee-Carter mortality model as applied to ABS mortality data of ages 65 to 109 years, and projections for longevity improvements based upon this model.

The individual’s superannuation account is assumed to be invested in a balanced portfolio consisting of 35 per cent Australian equities, 25 per cent international equities, 12 per cent domestic bonds, 8 per cent international bonds and 20 per cent cash investments.

Investment earnings are assumed to be taxed at 15 per cent of the annual earnings for super accounts.

The individual is assumed to withdraw (at the beginning of each year) from their retirement age onward an annual amount inflated (adjusted) in accordance with projected price inflation rate (CPI) until death. On retirement, the annual income required for a comfortable retirement is $42,861 (the ‘comfortable retirement standard’ according to ASFA’s retirement standard, June quarter 2015) and the income set for modest retirement is $23,662 (ASFA’s ‘modest retirement standard’).

Results and analysis

Using the calibrated SUPA model, we generate detailed future scenario outcomes with regard to the seven key economic variables. For these scenarios, we can vary the starting superannuation fund level and the withdrawal rates from the retirement age to simulate the annual level of the superannuation fund balance throughout retirement and thereby assess the probability of an individual’s funds outlasting their lifespan for a certain living standard during retirement.

Minimum fund level for comfortable retirement lifestyle with given success probability

The table above provides the minimum fund level required at retirement age to support a comfortable retirement with a certain success probability. Here, ‘success probability’ denotes the probability of the individual dying before their superannuation funds are exhausted. For example, according to the SUPA model, an individual requires $1,018,000 in superannuation at the retirement age 65 to have a 99 per cent probability of not exhausting their entire superannuation funds during their lifetime, while maintaining a comfortable retirement lifestyle, according to the ASFA retirement standard.

Similarly, we also provide details on the minimum fund level required at retirement age to support a modest retirement for various degrees of probability of success.

Given the large degree of uncertainty in estimating future investment returns and the required expenditure for a certain retirement standard, a more logical approach would be to provide the additional quantitative measure: the probability of success, when a minimum superannuation amount is cited for meeting a particular retirement living standard. For example, in the case of comfortable retirement requirement, if 95 per cent success probability is regarded as the acceptable risk tolerance level, the simulation result suggests that $851,000 is a sufficient superannuation balance at retirement age to achieve a comfortable retirement, and there is only 5 per cent chance of exhausting the superannuation fund during the retirement phase. When eligibility for the full age pension is met, a super balance at retirement of only $73,000 is needed to provide a modest retirement income, with a 95% probability.