How much wealth is enough?
My personal philosophy on wealth building is simple: invest slightly more than necessary to achieve my financial and lifestyle goals comfortably, but no more than that!
None of us knows how long we have left on this planet, so I think it’s essential to maximise enjoyment today or at least enjoy the wealth-building journey as much as possible.
Research consistently shows that experiences, rather than material possessions, deliver greater and longer-lasting happiness.
And your ability to enjoy experiences is dependent on health and time.
In short, invest a little more than you think you will need for retirement, to pass on to loved ones, donate, etc. and spend the rest on holidays with the people you love.
What do you do with property in retirement?
Most readers of this blog are property investors.
Investing in property offers two distinct advantages over other assets: (1) the power of gearing and (2) compounding capital growth.
Gearing accelerates wealth accumulation and is especially beneficial for investors who are still in the accumulation phase.
However, in retirement, when employment income ceases and you are solely reliant on investment income, gearing becomes less appropriate – or at least it is not appropriate to gear to the same level as you do during your working life.
That said, gearing is also less necessary if you have already accumulated a strong asset base.
Investment-grade property returns come predominantly in the form of capital growth.
Whilst property does generate income after expenses, it’s a low amount, relative to the investment value.
This provides a significant tax advantage during your working life, and capital gains are not taxed until you sell the property.
This means your capital growth is reinvested each year without tax.
This makes investment-grade property more tax-efficient than shares, which tend to provide a higher portfolio of income.
However, in retirement, in a tax-free environment like super, whether returns come from income or growth makes no difference, essentially equalising the tax efficiency between property and shares.
Put differently, the tax benefit of compounding capital growth that property provides whilst you are working can be replicated in super in retirement.
To summarise, property’s advantages over shares, being gearing and tax-effective returns, diminish in retirement.
I am not suggesting retirees necessarily sell all property holdings.
Diversifying across many asset classes, including property, minimises portfolio volatility and offers diversification benefits.
What I’m suggesting is that property investors would likely benefit from reducing their exposure to property investments after retirement, particularly because they should aim to maximise the tax-free advantages of superannuation.
If you have less than $4 million, put it all in super
Individuals can hold up to $2 million in superannuation each without paying tax on investment income or capital gains, and pensions drawn from super are also tax-free.
So, if you expect to have less than $2 million in investment assets (each) by the time you retire, and some of this wealth is held outside super, you should consider strategies to move this wealth into super in a tax-effective way.
It’s important to note that the Transfer Balance Cap (TBC), which is the term used to describe the amount of wealth you can hold in superannuation tax-free, is indexed in $100,000 increments.
This means if you are not planning to retire soon, you could eventually be able to hold more than $2 million (each) in super, tax-free.
- 1 July 2025: TBC will be $2 million per person.
- 1 July 2035: TBC could be $2.5 million per person (projection).
- 1 July 2045: TBC could be $3.2 million per person (projection). Note that this projected cap exceeds the proposed Section 296 tax limit of $3 million, which would apply a 30% tax rate on unrealised capital gains. It’s proposed that this cap will not be indexed. This is not the law yet, and of course, a lot can change over the next 20 years!
If you have more than $4 million
If you and your spouse have more than $4 million in assets, it probably makes sense to hold some of these surplus assets in personal names.
If individuals earn up to $45,000 in personal taxable income, they will pay an average tax rate of only 11%.
Any taxable income above $45,000 attracts a tax rate of 32%.
Therefore, assuming a 7% annual return, individuals can hold up to around $600,000 of investments in personal names (each).
If your wealth exceeds these amounts, it is generally better to hold any additional assets in a family trust or company.
In summary, for each individual, the first $2 million should be held in super, the next $600,000 in personal names, and any surplus beyond that in a company or trust.
How much would you like to have?
How much would you like to spend in retirement?
Once you have answered that, you can calculate the amount of investment assets needed to achieve this goal (refer below).
From there, you can project what you expect to accumulate with your current financial plan to determine whether you will have enough wealth, or ideally, surplus wealth, to meet your financial and lifestyle goals.
The table below shows the amount of investment assets required by age 60 (in today’s dollars) to support a specified level of living expenses.
I have assumed that individuals will spend more in the first half of retirement, with spending decreasing after age 80.
The calculations are based on the idea that by age 100, the investment asset balance will have reduced to around $200,000 in today’s dollars.
That is, you can afford to live until age 100 but not materially beyond.
In reality, most people before age 100 will likely be in a care facility, which can be funded through selling the family home.
If your goals include bequeathing money to family or charity, you will need to factor that amount into the figures above.
If you’ll have enough, why keep investing?
If I have a client who wants to spend say $120,000 on general living expenses plus $80,000 on travel each year in retirement, totalling $200,000 p.a., and if I am confident they are on track to accumulate more than $3 million in investment assets (in today’s dollars), then why should they invest more than planned?
If they have surplus income, shouldn’t they use it to enhance their current lifestyle?
Of course, more money won’t change everyone’s life.
In fact, I acknowledge there is a lot of power in living a simple life with fewer desires, and that is fine.
But the theme of this blog is not written for those people.
It’s for people who have worked hard, made sacrifices, and want to enjoy some of the rewards of their efforts today, without waiting until they reach retirement.
To reiterate, my personal philosophy is to invest just enough to comfortably reach my financial and lifestyle goals, but no more.
I don’t want to be the richest person in the cemetery.
That’s my goal, but of course, it is personal to me, and it’s not for everyone.
It’s often hard to break the saving & investing habit
In my experience, individuals who are very disciplined with saving and investing throughout their lives often struggle to shift towards spending more in retirement.
This could stem from being very comfortable with their current standard of living, or perhaps because a savings mindset is deeply ingrained.
Like many financial choices, the crucial aspect is simply to make well-informed decisions.
If you are sure that you will have surplus assets, then perhaps spending or gifting more today might give you more satisfaction than leaving it to your estate.
A relatively small sacrifice today avoids a large sacrifice later
The earlier you start investing, the fewer lifestyle sacrifices you will need to make.
Someone who begins investing in their 20s, for instance, only needs to contribute a relatively small amount over their 40-year working life to secure a very comfortable retirement.
But if you wait until your 50s to start, you will need to invest a much larger amount to achieve the same outcome, which probably means you will need to make some significant lifestyle sacrifices.
The reason for this is that time is the most valuable ingredient in any investment strategy.
Start early, invest consistently throughout your 20s, 30s and 40s, and perhaps you can enjoy the fruits of your labour in your later 40s and 50s, safe in the knowledge that you are on track to meet your retirement goals.
Investing is a habit.
And any habit is hard to break if you have been practising it for many years.
However, at some stage, it may be appropriate for you to spend more on the things you enjoy and invest less.
Post Comment