It seems difficult to think about in these challenging times, but the reality is a 3% employee KiwiSaver contribution rate is unlikely to provide for the retirement most of us look forward to. While our financial circumstances can make it hard to save more than this, saving even a little bit more each week can have a huge impact on your retirement. But what is the optimal contribution rate for savers if you can afford it?
How much gold do I need for my golden years?
Massey University conduct an annual study that provides a useful starting point for savers contemplating how much they need in retirement. In the 2019 study they calculate that a one-person household living in the city would need $764,000 to fund what they call a ‘choices’ lifestyle in retirement.
While this study provides a useful savings guide – savers have different lifestyles and expectations. A fixed dollar target also doesn’t help savers understand how much they need to save each year to build this nest egg. Below we discuss the percentage of income that savers need to invest each year to prepare for retirement, which depends on factors like when you start and what fund you select.
International evidence provides a guide
The Center for Retirement Research at Boston College estimated that to have a comfortable retirement, retirees should target a retirement income of 60-80% of their prior income. To replace 80% of their income in retirement they estimated that those starting at 25, needed to squirrel away 15% of their income until they are 65. Those that wait until 45 would need to stash away 41% of their income!
Looking at the compulsory contribution rates in other countries can also provide a guide. Across the ditch in Australia employers must contribute a minimum of 9.5% of each employee’s earnings into their superannuation account. This contribution rate is set to rise further to 12% in 2025. Denmark has a similar system to Australia, with a range on compulsory contribution rates from 9-17%. In Switzerland, the compulsory contribution rate starts at 7% at age 25 and ramps up to 18% for those aged 55 or over.
So how much do Kiwis need to save?
We are lucky to have NZ Super. This goes some way to replacing our incomes in retirement, but even factoring this in, Kiwis need to save a significant proportion of their income each year to be prepared.
We estimate that someone on the average income ($53,000 per annum) that starts saving for retirement at 35 would need to save 11% of their annual income (including any employer contributions) in order to retire at 65 and continue earning 70% of their prior income. If they save through a conservative fund, they would need to save 14%. If however they don’t start saving until age 45, then they would need to save 19% of their income each year if investing in a growth fund – a significant jump.
If you earn a higher than average income you may need to save an even a higher percentage. This is because NZ Super will contribute a smaller proportion of your desired retirement income. If, for example, your current income is $85,000 and you want to replace 70% of this in retirement, you would have to save 20% of your income from age 35 to 65.
Save like a pessimist, invest like an optimist
Saving 10%, 20% or more of your income may sound daunting - and it certainly isn’t an easy target given the cost of living in New Zealand. But keeping this in mind and trying to increase your contribution rate through time can really help. Perhaps you receive a pay rise, or see your expenses fall as kids leave home and you pay off your mortgage. That would be a good opportunity to up your contribution rate.
There is a lot of wisdom in the saying that you should save like a pessimist but invest like an optimist. It implies that you should start saving early and increase your contributions whenever possible. Taking an optimistic view on the long-term outlook for the economy and putting your money to work in a growth fund is also more likely to help you achieve the retirement you desire.