Beyond the 4% rule – managing retirement spending

Retirement marks a pivotal shift in your financial management – from focusing on earning and saving money to utilising your savings to support your income needs.

Contrary to the common perception that wealth accumulation ends with retirement, successful retirement relies significantly on the continued growth and careful management of life savings. In fact, over the course of a typical retirement, just 10 percent of income derives from money saved during working years, while 30 percent comes from investment returns earned before retirement and 60 percent from returns accrued post-retirement.1

In fact, one of the key challenges for retirees is that many are not spending their superannuation savings sufficiently, leading to a lower quality of life than needed. Shifting from a ‘nest egg’ mentality towards a balance between preserving capital and drawing enough savings to live a comfortable lifestyle is an important part of crafting a retirement spending plan.

Life expectancy, health status, the presence of dependents, lifestyle choices, and the size and composition of pre-existing wealth all play critical roles in shaping financial decisions.

Therefore, understanding and adapting to these personal factors is vital for crafting a retirement plan that manages spending effectively by adapting plans over time, and addresses the unique challenges faced by retirees in different decades of their retirement.

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Thinking about retirement, but not sure where to start? Get tips and information in our Planning for Retirement guide, to help you get started today.


Retirement readiness: working backwards from spending

Knowing whether you have enough money to live comfortably is for many the paramount question of retirement.

Retirement brings changes that will shift your spending habits and alter your financial needs. The daily expenses associated with working life, such as commuting and professional attire, generally decrease, while recreational spending on hobbies and travel may rise.

Fundamentally, it is a question of how much you have saved and whether those savings will cover your future needs – and assessing this requires a blend of strategic planning, forward thinking and a few assumptions.

There are tools and calculators online that can help you think this through, including the ASFA Retirement Standard and BT’s Retirement Calculator, which allow you to estimate spending by adjusting for anticipated changes and different financial scenarios.

Many retirees solve the problem of not knowing if they have enough by withdrawing the minimum amount they are allowed.2 But this leads to another problem – arbitrarily reducing income and living standards below what they need to be.

A better approach is to spend some time considering how your spending will change in retirement – and working backwards to figure out what you need saved and how those savings should be invested.

BT’s Retirement Calculator shows typical retiree spending on groceries, transport, clothing, entertainment and other costs and lets you adjust the numbers to suit your own personal circumstances.

Once you know your likely spending you can then calculate the savings and investments needed to support your lifestyle.

This approach helps you build a more complete understanding of your finances and allows you to plan more confidently.

Of course, these can be complicated questions. For some, the assistance of a financial adviser can help with tailored advice including how savings interact with eligibility for government support like the Age Pension.

Understanding the 4% rule

Once you understand your anticipated spending in retirement, you can begin to calculate the necessary savings and investments required to support your lifestyle. A popular guideline for this is the 4% rule.

The idea is simple enough – a retiree that withdraws 4% of their savings in the first year of retirement, and then adjusts that withdrawal annually for inflation in each subsequent year, stands a good chance of not running out of money.

The origins of the rule are in a 1990s paper from William Bengen, a Californian financial planner who analysed 75 years of actual market returns.3 In later work, Bengen explored adjusting his number higher, but the 4% benchmark has stuck.

The simplicity of the 4% rule – you can simply multiply your annual expenses by 25 to determine how much you need saved – belies its underlying complexities.

One common misunderstanding is that the rate of withdrawal continues to be 4% of savings every year. However, the rule specifies that the 4% withdrawal is meant for the first year only, with subsequent withdrawals adjusted for inflation rather than portfolio growth. A retiree withdrawing 4% of their balance every year is not applying the rule correctly.

Moreover, the rule does not account for changing spending patterns across the course of retirement such as increased medical expenses or changes in lifestyle.

And the 30-year retirement period the rule was designed to cover – Bengen assumed retiring at 65 and living to 95 – may not align with everyone’s life expectancy or retirement plans.

How to plan a retirement budget

One way to think about retirement is to break up your planning into decade-by-decade chunks.

As you age, your financial needs and lifestyle preferences will most likely change and optimising planning accordingly can ensure comfort and financial stability throughout the different stages of retirement, without unnecessarily compromising your lifestyle or enjoyment.

Overseas research indicates that retirement spending typically shows peaks early on – when retirees are more active and likely to incur travel and leisure expenses – and later due to increasing medical costs. The resulting curve is sometimes dubbed the ‘retirement spending smile’.4

In Australia, this pattern is less clear cut. Australians generally spend less in retirement than they did while working and as they age, spending tends to stay steady or even fall. Partly, this is because of government support that limits out-of-pocket healthcare expenses.5  The ASFA Retirement Standard breaks spending into two periods – a period of higher spending ages 65-84 years and then lower spending after age 85 years.

Still, taking a decade-by-decade approach can help you plan for the different types of spending you might need.

Here are some practical steps to optimise your retirement budget:6

Assess your current financial situation: Using the ASFA Retirement Standard and BT’s Retirement Calculator as reference, categorise and estimate your likely spending. At the same time, record how much money you have coming in, including any paid work, pension, super income stream, or government benefit.

Pay off any remaining debt: If you still have a mortgage or other debts, consider paying them off to reduce the impact of ongoing interest payments which can often be bigger than any extra income generated from investing that money instead.

Plan for unexpected expenses:
Maintain an emergency fund in investments that prioritise capital preservation and liquidity over returns, and that can be accessed quickly and without penalty, such as a high interest savings account. An emergency fund can also help you ride out market downturns without being forced to sell assets, mitigating sequencing risk – the risk of needing to make withdrawals during times of poor returns, which can deplete your savings more rapidly.

Optimise spending:
Plan to spend your money in a way that maximises your lifestyle across your retirement. Remember that your needs will change as you get older:

  • Early years: budget for spending on travel and hobbies while you are still active and health permits. Consider setting aside a portion of your retirement savings specifically for travel and leisure activities to take advantage of these years.
  • Mid-years: as you progress through your 70s, expect spending on transport, recreation, clothing, alcohol and eating out to naturally decline.
  • Later years: into your 80s and beyond, spending tends to fall further as many retirees reduce discretionary outlays as they become less active. Rising health costs do have a small impact, but they are largely offset by declining spending elsewhere.7

These patterns hold true even for wealthier retirees and are a good basis for planning.

Professional advice can help you map this out in a way that considers your own circumstances and preferences.

If you have started considering what retirement might mean for you or if you are working on a plan for a great future, we can help you to understand what you need to think about.
Fully embracing the opportunities of retirement means maintaining good mental and physical health.
It can be all too easy to avoid estate planning. No one likes to think about death, complicated family relationships can make planning tricky, and it can be distressing to contemplate a time when others control all you have worked for.


Things you should know

The article was prepared by BT. BT is a part of Westpac Banking Corporation ABN 33 007 457 141, AFSL and Australian Credit Licence 233714. This information is current as at 1 July 2024. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to these factors before acting on it. This information may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. Any tax considerations outlined in this publication are general statements, based on an interpretation of the current tax law, and do not constitute tax advice.  The tax implications of super investments can impact individual situations differently and you should seek specific tax advice from a registered tax agent or registered tax (financial) adviser.