November 26, 2020

When Should You Start Saving for Retirement?

When Should You Start Saving for Retirement?

Are you currently saving for your retirement? If not, it’s better to start now rather than later because the earlier you start saving for retirement, the easier it’ll be to afford and the sooner you can start building on the power of compound interest. 


‍Especially if you’re still young, retirement may feel like a long way away, but in the retirement game, the early bird gets the worm. With the power of compound interest, you’ll have a whole lot more money in retirement than someone who started saving many years later – even if you contribute the same principal amount. 

While it’s important to think about saving for retirement now, you should also look at where to save your money, how to invest it, and how much to save. Planning for your retirement is essential if you want to live comfortably in your golden years.


"In planning for your retirement, there is really no stage in life that is too soon to start saving. Compulsory superannuation payments made by employers allows Australians to begin saving for their retirement as soon as they enter the workforce, and in a way that does not affect their current disposable income."
-Matt Shephard, Insolvency Officer


Retirement Fund Definition

A retirement fund (or super fund as it is called in Australia), is an investment of your own income that is set aside during your working life for when you will eventually retire. It’s basically a retirement savings account that you can’t access until you get older! In Australia, employers are legally required to pay a portion of your wages into your super account on your behalf. This payment is called a “super guarantee contribution”. Once you retire, your retirement savings will provide a regular source of income so that you can live more comfortably and don’t need to rely on a social security pension. 


Why You Should Start Saving Now for Retirement

It’s best to start saving for, and adding to your retirement fund when you’re in your 20s, as you can take advantage of the power of compound interest over the long term. If you set up a good plan, you’ll only have to save a few thousand dollars a year until you retire. For example, if you save $4,500 a year for 45 years (starting at age 20) with a 4% annual return, you’d have saved $1 million by the time you retire at age 65.


Even if you’re not in your 20s, it’s never too late to start saving - the catch is that you just need to save more each year. For instance, if you’re 30, you have to save $9,000 a year to reach $1 million. If you’re 40, you’ll need to put away $18,000 a year. And if you’re 50, you should save $40,000 a year.


On the other hand, if you start saving at age 25, and put away $3,000 a year in a tax-effective retirement account for 10 years, and then you stop saving, you’ll have $338,000 when you’re 65. This assumes a 7% annual return. If you wait until you’re 35, and then save $3,000 a year for 30 years, you’ll only have $303,000 by the time you reach 65. That’s a really big difference, and that’s the power of compound interest.


No matter how old you are, don’t wait until later in life to think about how you will fund your retirement! Knuckle down and make a plan to save for your retirement now!


"Due to Australia’s ageing population, it is very much expected that the Government will continue to reduce and limit accessibility to welfare payments (e.g Age Pension) with support only to be provided to those in dire need. To avoid having to worry about how much you can receive through Centrelink upon retirement, it is essential to focus on your superannuation sooner rather than later (whether through researching the right fund for you or even making additional contributions) to ensure you can finance your own retirement."
-Matt Shephard, Insolvency Officer


"I will have a pension when I retire anyway, so why do I still need to save?"

This might be the question you have in your head right now. Sometimes you might think that saving for retirement can be as hard as pulling out your own teeth! We might not want to admit it, but instant gratification is far more rewarding in the moment as compared to focusing on savings and investment. This is especially the case if you are young and still have many years before retirement becomes a reality. However at the end of the day, if you plan on living to the end of your life (which most people do), making a small sacrifice now can be the difference between retiring frugally or retiring comfortably. 


The startling fact is that in Australia, relying on the pension alone may not be enough to cover your lifestyle expenses once you get to an age where you can’t work anymore. According to the Organisation for Economic Co-Operation and Development (OECD), the average life expectancy for Australians is age 83, whereas the average Australian retirement age is currently 65 (this is currently the age at which you can start receiving the Age Pension from Centrelink) – that’s approximately 18 years of expenses to cover!

Given that the amount you received on Centrelink is so low, pension money only covers enough for basic needs like food and rent. When big expenses come along, such as needing to pay for medication, health insurance and medical expenses, if you don’t have a decent lump sum saved up, you won't have anything to fall back on! Notwithstanding healthcare costs, relying on the pension won't give you much room to pay for things like home maintenance, gifts, music, utilities, cars, eating out or vacations. Therefore, make it your habit to save right now while you still can.


Where To Save Your Retirement Money

save your retirement money in a retirement fund or superannuation fund

The best place to save your retirement money is in a retirement fund or superannuation fund. Make sure to compare super funds and retirement accounts (including interest rates, fees, etc.) and then choose the right one for your needs. Remember that the money in these accounts can only be taken out once you’ve retired. With so many decisions to make regarding your super, it’s easy to just go with whatever default option is served to you – however, your super is your future, so it deserves some thought! 


Because there can also be tax and insurance implications for some of the decisions you make regarding your super, it is recommended to seek the advice of a fee-for-service (not commission-based) PIFA certified independent financial planner in Australia. Why should you see an independent financial planner over any other type? Check out this video:


When you start working, you can choose a super fund or let your employer choose one for you where they’ll contribute at least 9.5% of your annual income into the fund every year until you retire. Under Australian legislation, this Super Guarantee Percentage amount is set to increase up to 12% by 2026. Moreover, you can make additional contributions into your super fund to increase your retirement savings and reduce your taxable income. In order to maximise the power of compound interest, it’s best to go for an indexed, diversified index fund with low fees.

In Australia, there are a lot of different funds to choose from, and typically, diversified balanced index funds also outperform funds that are actively managed by “finance experts”. If you choose to do your own research, make sure you understand the terms, conditions and fees outlined in the PDS before you make changes. Researching and understanding the ins and outs of superannuation laws and the fine print can be quite complex, and this is where paying for an independent financial planner to do the research for you will pay dividends over the long term!


You could also put away money into a self-managed super fund (SMSF) or an individual retirement account, where the money you save can build up tax-free until you retire and start making withdrawals. If you do set up an SMSF, you will need to deduct a portion of your wages automatically into the SMSF to ensure that you stick to saving for retirement. Whilst coming up with your own retirement plan can seem like a good idea, it can be legally complex, expensive and time-consuming - therefore, it generally makes more sense for the average person to go with an established Australian super fund. 


"It is highly recommended that people find a fund with low ongoing fees, with a proven track record of high performance and once the funds are in the fund do not remove until it is time to retire. This will allow any payments made into the super fund to accumulate at a fast rate through the effects of compounding interest and maximise your overall funds available once ready for retirement."
-Matt Shephard, Insolvency Officer


How To Invest Your Money

There are many ways in which you can invest your money and earn a decent financial return. Look at investments that can help you build massive wealth over the long term thanks to the power of compounding interest, such as bonds and stocks. Investing your money in bonds is generally classified as a less risky investment approach, however, compared to stocks, bond returns are usually lower. For example, bonds could earn approximately 5% a year, whereas stocks can provide returns of around 10%.


Stocks are renowned for their volatility, and as exemplified by the GFC in 2008 and in March of the Coronavirus Crisis of 2020, the market value of stock securities can go through steep downturns. As a general rule of thumb for asset allocation, if you’re more than 20 years away from retirement, you should hold 70% of your portfolio in stocks and 30% in bonds. Conversely, when you reach a later stage in retirement because bonds offer a steady and pre-defined source of income, they typically provide better protection against the volatility of stocks. With a balanced approach to asset allocation, you’ll be able to handle the market downturns, as well as see more positive returns and fewer major losses. If your super is invested in a super fund, your portfolio will automatically be balanced for you, however, you should also get the option to adjust the asset allocation at your discretion – simply get in touch with your fund. Whether you choose to invest additional funds through your super or make additional investments outside of it is a personal decision, and a good financial planner will be able to help guide you. You may wish to do both. 


Outside of super, you can choose to invest in mutual funds (just be careful of fees), index funds (e.g. an S&P/ASX 200 index fund), target-date funds and exchange-traded funds, as they can offer low costs and are simple and stable. It’s important to diversify your investments and reduce your overall portfolio risk. When comparing different types of investments, look at fees and expenses (lower is better) as well as performance – but remember, even the finance professionals on Wall Street get it wrong in the long run when compared to balanced, diversified index funds. 

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How much should you save?

The amount of money you should save will depend on how much you’re earning and how much you’ll need in retirement. When your income increases, your savings should too. Generally, you should have at least 70% of your former annual income for every year you’re retired if you want to live comfortably and be able to pay the bills and unexpected expenses.

But if you also want to build your dream house, travel the world or get a PhD, you might need 100% of your yearly income. Really think about how you want to live in retirement and how much it’ll cost, as this will determine how much money you need to save. Also look at your current expenses and then estimate how they’ll change. For example, you could be finished paying off your mortgage so you won’t have commuting costs, but your medical costs will most likely rise.


If you have a lot of debt that’s getting in the way of you saving for retirement, why not call Credit Counsellors today on 1300 003 328 and see how we can help you pay off your debt and get your finances ready for your golden years.


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