Planning for retirement is a complex process. It is no wonder then that impending retirement is one of the main triggers for individuals or couples to seek financial advice.
OPINION: There is a subtle hint of nervousness evident in people in their final working years. There are so many uncertainties and questions to be answered. Have I saved enough to retire?
Can I afford to retire early? How can I invest my money to provide a good income without losing it?
Retirement planning is much more of an art than a science. There are many variables to consider, including expectations around longevity, health, lifestyle, investment returns, bequests, cost of living, income requirements and lump sum requirements.
It is increasingly common for people to spend twenty to thirty years in retirement. Being able to foresee financial needs over that time frame is not easy.
The starting point for any retirement plan is to prepare a retirement budget for both ongoing income requirements and lump sum expenditure. One rule of thumb commonly used for a retirement income budget is to take a percentage (say 70 per cent) of current earnings.
This approach can easily overstate or understate the actual income required. An alternative method is to use the current level of New Zealand Superannuation (see www.winz.govt.nz) as a base level of income sufficient to provide the bare necessities of life and to add an amount sufficient to cover the 'nice to haves' such as entertainment, sporting or club activities and domestic travel.
Alongside this, prepare a separate budget for lump sums required for large expenses such as replacing the car, maintaining the house and contents, overseas travel and healthcare.
The next step is to use a retirement calculator (see www.sorted.org.nz) to work out the lump sum you will need at retirement and how much you should save each year to get there.
With any complex situation, it is always best to consider alternative scenarios based on different sets of assumptions. This will give a range of possible outcomes as a benchmark. In your calculations, always plan to live a long time to lessen the risk of running out of money.
Don't plan on being able to work either full time or part time for an indefinite period, as your health or other employment factors may force you to stop work earlier than expected.
If you want to work past retirement age it should be by choice rather than because you can't afford not to.
To help with the calculations and also with your investment strategy, try breaking your retirement period into three separate stages:
1. The 'live it up' stage. This is the most active stage of retirement where money is spent on physical activities such as sport and travel and just getting out and about enjoying life.
2. The 'fix it up' stage. If you upgrade your car and home décor at retirement chances are that ten or so years into your retirement you will have to do it all over again. During this stage you might also need to spend money on your health for such things as hearing aids, cataract operations or hip replacements.
3. The 'wind it down' stage. In the final years of life, you may need to pay for someone to care for you in your home or you may want to allow for moving to a retirement village or rest home.
Allocating part of your retirement nest egg to each of these three stages means the funds can be invested differently if you choose, depending on how long you expect each stage to last.
For example, money for the first stage can be invested in shorter term income assets such as bank deposits whereas money for the third and possibly the second stages can be set aside in longer term portfolios based on growth assets to keep ahead of inflation and tax.
Get familiar with investing in assets other than bank deposits sooner rather than later so that you have a wider range of investment options open to you that you feel comfortable with.
Over the last five years or so of your full time working life, the best way you can prepare financially for retirement is to start living on what you expect your retirement income to be.
This has two beneficial effects; firstly, it helps you adjust to a lower level of income before you have made a commitment to that level of income, and secondly, it helps you add even more to your retirement savings. This trial period may be enough to convince you that an early retirement is not what you want after all.
Liz Koh is an Authorised Financial Adviser and author of Your Money Personality; Unlock the Secret to a Rich and Happy Life, Awa Press, 2008. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847.