Here’s Why Those on Top Incomes Face a Funding Crisis in Retirement

Financial Advisors Perth | Empire Financial Group

Raymond P

MD Empire Financial Group

Raymond is the founder and Managing Director of Empire Financial Group, and a Responsible Manager of our Australian Financial Services Licence, EFG Advice Australia.

This article first appeared in The West Australian, Your Money, on 3 July 2023

By Raymond Pecotic

Wealth is a relative measure. Rising interest rates, and the impact on savings and buying power, has left many people feeling less wealthy than they did a year ago.

In a resources-rich State, with six-figure salaries the norm for even the most basic of mining-related jobs, our view of wealth can easily become distorted.

It may surprise many that earnings over $122,664 a year will place workers in the top 10 per cent of income earners, based on recently released Australian Taxation Office figures. Even more surprising to many is that to be in the top one per cent you need to have earnings of $253,066.

The reason I suggest this would be surprising is that we see many people in those income brackets who would not feel they would statistically be better off than 90 people in a group of 100, let alone those who would look around and think that they are living better than 99 of them.

With rising incomes comes lifestyle creep — where increases in income lead to an increase in spending on living expenses and non-essential items. Put simply, items that consumers once felt were luxuries over time become perceived necessities.

This is a significant factor in the perception of wealth. It is also a significant factor in preparing for retirement.

A big portion of the population takes a passive approach to preparing for retirement. They buy a house and embrace lifestyle relative to their incomes and leave saving for the future to the mandatory superannuation system.

For many people that could be a viable solution. The government-mandated super system was created with the needs of the average worker in mind as a replacement for, or significant added boost, to the age pension.

The percentage of wages required to be put aside, as well as maximum caps on contributions, are intended to largely meet the requirements of those whose income — and therefore lifestyle requirements — fall within the averages of our workforce.

But what about those whose income, and therefore lifestyle, do not meet those averages?

For workers in the top 10 per cent of income earners, do the standard super contributions meet their future retirement requirements? And what about those who earn even more?

Unfortunately for higher income earners with higher lifestyle expectations, hoping the government-mandated super system will solve their retirement requirements will leave them bitterly disappointed.

We have run some numbers on how long super will last based on different income and lifestyle levels. Our assumptions are based on a 40-year-old with a starting balance of $100,000 in super. We assume that they put 30 per cent of income towards their mortgage, and that at higher income levels the value of their house rises accordingly.

The mortgage is designed to be paid off by 65, with basic employer super contributions only at long-term earnings of 8 per cent a year. All remaining net income after mortgage repayments goes to living expenses.

We also make the assumption that as income increases, lifestyle creep sets in — bigger house and lifestyle expectations. For basic illustration purposes, we assume that living expenses during working life continue through to retirement — that is, lifestyle expectations stay the same.

What do the figures indicate? The table below tells the story.

Taking a passive approach to preparing for retirement can work really well for a $100,000 income earner. As long as they pay the mortgage off by 65, what they have been living off after home loan repayments can be satisfied with their super balance, assuming a capital drawdown. As capital is drawn, Centrelink will kick in to supplement drawings from super. Their money will last to age 90, which is beyond current average life expectancy of 83.

A $250,000-a-year income earner is in a different situation. Basic super contributions will give them a balance that will have funds depleted right at life expectancy of 83. They would be getting pretty nervous for the last four or five years, particularly those in good health expecting that they will live many good years beyond 83.

However, the big hitters who live large and don’t take proactive steps to prepare for future passive income streams are the ones in the greatest trouble.

Concessional super contributions cap out at $27,500 regardless of how high your income gets. This means super balances also cap out, while lifestyle expectations rise. Increased income drawn from a capped balance means higher income earners will go broke in retirement sooner.

For those on more modest incomes, it may seem crazy that such high income earners are often ill equipped for a secure retirement. I can assure you from years of experience that it happens. Lifestyle creep often means adequate future plans are neglected.

So what’s the solution? If you find yourself in the top 10 per cent of income earners, it is important you know your numbers — exactly what your living expenses are, what your mortgage is — and map out a plan to secure debt-free accommodation, and peg your lifestyle and investment plan at a level that it can seamlessly transition from working life to passive income streams.

It’s not about chasing investment returns hoping a higher return will paper over cracks in your cashflow and regular investment plan. The figures tell us that won’t do the trick.

It may not sound as exciting, but the most reliable and effective solution is always a properly modelled plan, showing the impact of different lifestyle choices, and accountability to debt management and a constant, consistent and conservative investment plan.

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