For many New Zealanders, retiring before age 65 is the lifestyle Holy Grail. The dream is to kick back, spend time with family, friends and loved ones, and travel heaps. They subscribe to the view of “casting off the drudgery of day-to-day work and enjoying the good times as you only live once!”
It sounds appealing but many who attempt early retirement find the financial burden too tough, and by then it might be too late.
There are some harsh realities linked to any talk of an early goodbye to one’s working years - and savings is at the top of the list. “By and large, early retirement only makes sense for individuals who have enough saved to cover 70 to 80 percent of their pre-retirement income, as that’s usually the amount needed to maintain one’s standard of living in retirement,” said Karen Wimbish, senior vice president at US Bank Wealth Management.
In addition to typical retirement planning strategies, those thinking of early retirement need to consider immediate as well as long-term considerations. Five key steps to consider are:
Assess likely expenses:
Expenses associated with property, tax, insurance, travel, updating household items, assisting kids etc all need to be thought through and added up. It is common to find that lifestyle expenses such as entertainment, dining, and travel may increase in retirement. You may also start to periodically look after the grandchildren and not surprisingly, you tend to spend money on them.
Understand your income sources:
On the opposite front, tally up all income from sources such as KiwiSaver, pensions, investments, and term deposits. Then work out the order in which to withdraw from these sources to minimise tax and maximise the growth potential of remaining assets. Logically, you would consume cash resources first as these are fully taxed and earn you the least amount of money. Leave investments such as managed funds, KiwiSaver, etc to last especially if you are prepared to move them to higher risk funds due to not needing to access them for many years to come.
Understand the access to those sources of income:
One of the challenges of early retirement is working out how to access the money you need when you need it. This is a very different mindset to that of budgeting when you had a steady income in your working years. Pre-65 means there is no New Zealand Superannuation fortnightly payment so meeting day-to-day expenses such as food, petrol, household expenditure etc needs to be covered by income from other sources. The tendency is to hold too much in cash or to develop an investment portfolio that is strongly income orientated. This might sound logical but the reality is early retirees may need their assets to last them over 25 years so a strong growth component to keep ahead of rising prices needs to be maintained. This is where the team at Milestone may talk to you about the ‘water tank’ theory. Effectively, you work out the amount of cash you need for the next 12 months and this is deposited into your account. Two or three years of income needs are retained in a low-risk portfolio in case you need access to some unforeseen lump sums and the remainder is kept in a more growth orientated portfolio so it can continue to grow for the longer term.
Plan ahead - way, way ahead:
This step is really more applicable to younger retirement savers, but the fact is, the sooner you start planning for early retirement, the better the chances of achieving it. The simple fact is that early retirement requires you to have much more money accumulated to take you through a longer period in retirement. The amount required may not be achievable to accumulate especially if you decide only a few years out from the early retirement date.
Plan for unexpected purchases:
Everyone needs to have a spending plan in retirement, but a key part of that is planning for big purchases that aren’t on the spending radar right now. Allow for big purchases and emergencies separately from investment funds so when average investment return is calculated, those funds are not included in principal. Common items overlooked include:
- Replacing the car at least twice in retirement. The current car may be debt free but the new replacement will likely cost significantly more than the sale price of the old one.
- Spending on the kids or grandkids. This is becoming more common as house prices and university education costs increase.
- Taking up a new sport or hobby. As an example, cycling is becoming more popular for retirees and it is not uncommon for an early retired couple to spend $15,000 or more on the latest pushbikes, clothing and related items.
- Purchases for the house. A couple now spends more time at home than previously so the temptation to make the home surroundings nicer is often huge. It is common to see over $20,000 spent on household items such as new curtains, carpet, landscaping, sound system, and furniture. All this is before spending money on the really big ticket items such as a bathroom or kitchen upgrade.
Retiring early is not an impossible dream. It is easily achievable for those with a high asset level. However, for the average New Zealander, it is simply a dream unless advance planning is undertaken and the five steps listed above are realistically thought through. The team at Milestone are skilled at helping clients identify when they are financially able to retire. Give us a call.