There are plenty of Singaporeans who have the capacity to retire, but still find themselves working. Some of these people work because they enjoy it, and that’s a great thing. But at the same time, some of them keep working out of fear. Many of us have a nagging suspicion that if we stop working now, we can’t start again (we’re too old to be rehired, etc.) and haven’t built a big enough retirement fund.
To allay your worries, here are some guidelines on when it’s “safe” to truly stop working:
1. Check if your retirement expenses meet the “4% guideline”
The 4% guideline states that, assuming you retire at around 65, your retirement fund can safely last till 90 if you withdraw only 4% of it every year. For example, if you have a total retirement fund of $350,000, you can withdraw up to $14,000 a year.
Balance this figure against how much you think you’ll spend, when you’re retired. In the above example, you would have around $1,166 a month to spend.
The 4% guideline is not simple guesswork. It is derived from a study in 1994, by financial planner William Bengen. Bengen’s study revealed that between the 1930s to 1970s (a period marked by multiple market crashes from the disruption of WWII), no retirement portfolio with a 4% withdrawal rate lasted less than 33 years.
To go a little more in depth: the “4%” withdrawal mainly consists of dividends, coupon payments, or other sorts of income streams provided by your retirement assets. This is actually based on one of the oldest approaches in personal finance called “spend the interest and not the principal”.
For example, say you retire with $1 million in assets and the assets generate returns of 2% per annum, you thus get $20,000 every year from the returns alone. This is sufficient for you to withdraw around $1,600 every month, for an indefinite period, as long as (1) the returns don’t change, and (2) you don’t touch the invested amount (the principal).
However, note that the 4% rule is not endorsed by every financial planner. Your retirement portfolio must be built to support this approach. If you have a portfolio of high volatility stocks, this may not work for you. You might want to consider something more consistent such as the methods we describe in Dividend Machines.
Also, some financial planners criticise this method as being unrealistic. You may not always be able to live on the fixed monthly amount. For example, a medical emergency might force you to spend three or four times the usual withdrawal sum. You may need a contingency plan such as a good health insurance policy to cover these other aspects.
That being said, the 4 % guideline is still a useful guidepost on whether you have sufficient assets to retire on.
2. Aim for an 80% income replacement rate
Your income replacement rate refers to the percentage of your pre-retirement income which you have after you retire. So if you are earning $50,000 per annum and you have a replacement rate of 80%, you would have around $40,000 per annum upon retirement.
The range determined adequate by the World Bank – and which is seen in most developed countries – is between 53% to 78% across the board. Our Central Provident Fund (CPF) also estimates that a replacement rate of 70% will be typical for most Singaporeans entering the workforce at around 2010 or later.
We suggest aiming a little higher than the typical 70%. With a balanced portfolio and disciplined savings combined with the reliability of the CPF Special Account, this is quite possible.
Note that the common guideline among local financial planners that we need $1 million to retire in Singapore is based on this rule and the 4% rule (in point 1). The typical Singaporean makes around $50,000 per annum and taking out $40,000 per annum is taking out 4 % of $1 million.
That said, you do not have to adhere too stringently to this guideline. Some people can live on less than others. If you earn $50,000 per annum but can happily retire on $20,000 per annum, you can probably retire much earlier.
3. You should have no outstanding debt
This should be obvious, but we’ll mention it anyway because it’s important.
As far as possible, try to retire without any interest accruing debt. For the sake of reference, typical debt interest rates are as follows:
- Credit cards: 24% per annum
- Personal loans: 4% to 7% per annum
- Car loans: 2.78% per annum
- Renovation loans: 5% per annum
- Mortgage: 1.3% for bank loan (at time of writing), 2.6% for HDB loan
As you can see, most of these significantly exceed or eat into the returns from your various retirement assets. Your retirement isn’t really “safe” until you’ve finished paying off your debts.
If you absolutely can’t pay off all of them, make sure you get rid of the higher interest debts first. You can survive still having an outstanding mortgage but you’re going to struggle when dealing with personal loans.
4. At least 20% of your assets should move with inflation
It’s not a good idea to have only fixed income securities as your retirement assets. Even though the rate of inflation is quite consistent in developed countries (around 3% per annum), it’s not impossible for sudden spikes to occur. A long period of inflation, say seven to 10 years, can derail a retirement fund. For this reason, try to keep at least 20% of your retirement fund in assets that can move with inflation.
For example, consider a perpetual income bond versus a room you can rent out.
The perpetual income bond pays out $1,500 a year. Now in 30 years’ time, $1,500 will not be worth as much as it is today. If things carry on at the current rate of inflation, the purchasing power of $1,500 in 30 years might be as little as $825 today (55% reduction in purchasing power over 30 years).
There’s nothing you can do about that as the bond is a fixed income security. That’s why the bond issuer agreed to giving you a perpetual income in the first place: they know the amount they pay would dwindle to irrelevance over a long time.
But if you have a room you can rent out, you can raise the price along with inflation. As the cost of living goes up, rental rates will probably also rise. So while the rental income may fluctuate, you know that it will more or less keep pace with inflation.