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Retirement rules of thumb

Everyone’s road to retirement is personal, with twists and turns that are unique to their situation. Yet most of us grapple with the same, sometimes elusive, questions, usually starting with: “How much do I need to retire?” 

Of course, no one knows the precise answers to these questions because you don’t know what life—or the markets—will bring. Still, you need to know where you stand to make decisions along the way that will help you have choices as retirement nears.

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That’s why we did the analysis and determined guidelines based on 4 key metrics: an annual savings rate, savings milestones (savings factors), an income replacement rate, and a probable sustainable withdrawal rate to start you on the path to creating your retirement roadmap and see point 1 in below disclosure.

They are all interconnected, so it is important to keep each in mind, and to understand how they work together, as you save for retirement and monitor your progress.
We will focus on each metric – and associated guidelines – in separate articles, and we’ve included tools interactive widgets to help you explore the impact of changing assumptions on these individual guidelines.

Here are 4 common retirement questions – and rules of thumb for each assuming a retirement age of 65, which is the retirement age of Mandatory Provident Fund (MPF) that most working people in Hong Kong may have participated.  Of course, your particular needs may be different, which is why you should consider working with a professional to build a personalized plan. But the following guidelines offer a starting point.

 

  • What will my savings cover in retirement? For most working people in Hong Kong, first part of their retirement savings will come from their occupational retirement plans like ORSO (Occupational Retirement Scheme Ordinance) or MPF with the rest coming from savings. But how much should you assume will come from savings?  Fidelity’s rule of thumb is to save enough to replace at least 48% of your pre-retirement income (including the savings from your ORSO or MPF), and see point 2 in below disclosure.
  • How much do I need to retire?  It’s a tough question to answer, particularly when you are years away from retirement. One simple way of estimating and monitoring your retirement savings goal is with our age-based savings milestones. These are factors expressed as multiples of your current income. Based on our analysis, we suggest aiming to save 2x your current annual income by 30, 5x by 40, 8x by 50, 11x by 60 and 12x by 65, , and see point 3 in below disclosure for details.
  • How much should I save each year for retirement?  For a high level of confidence that you can maintain your lifestyle in retirement, we suggest aiming  to save at least 20% of your pre-tax income (see point 4 in below disclosure) a year over the course of your working life. Of course, you may not be able to do this every year, but there are always way to catch up along the way. 
  • How can I make my retirement savings last? One of the most challenging questions many retirees face is how much to withdraw from their savings in retirement. Withdraw too much and you risk running out of money. Withdraw too little and you may not live the life you want to in retirement. Our guideline is to limit withdrawals to 4.1% of your initial retirement savings (see point 5 in below disclosure), then keep increasing this withdrawal based on inflation.

Illustration 1

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Disclosure: 
Income replacement rate: The percentage of pre-retirement income that you will have to fund from savings and occupational retirement scheme like MPF or ORSO, as well as an Old Age Allowance from Social Security Allowance Scheme where applicable, in order to maintain your lifestyle when you stop working.
Savings milestones (factors): The multiple of your annual pre-retirement income your should have saved by retirement.
Probable sustainable withdrawal rate: The percentage of savings you should withdraw annually as retirement income so that the savings last, but no money is left on the table.
Savings rate: The percentage of income you should put aside along the way.

Retirement age is key
All these guidelines depend on a number of factors, especially age at which you retire. MPF benefits can be claimed at age 65 and Old Age Allowance at age 70.  Retiring early will decrease the period over which your retirement savings can grow. Delaying retirement will have the opposite effect, extending the period over which your retirement savings can grow, and reducing the number of years in retirement to be funded by those savings. 

So the age at which you choose to stop working can have a big impact on how much income you need from your own savings. This, in turn effects the values for other retirement guidelines – savings rate, savings milestones (factors), and probable sustainable withdrawal rates (see illustration 2). Remember, these guidelines are all linked together.
 
While you may not be able to pinpoint exactly how much income you may need in retirement, you probably have an idea about when you want to retire. If you're planning to retire early, you may want to use the rules of thumb for age 62. If you are planning to work longer, the rules for age 70 might be more appropriate for you.

Illustration 2

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Assumes saver age 25 with HK$25,000-HK$150,000 in income before retirement and more than 50% on average in stocks during working years. See the endnotes for methodology and other key assumptions.

Things to keep in mind
Our guidelines assume no pension income, and we make a number of other assumptions, including continuous employment, uniform wage growth, and contribution amounts increasing with the wage growth. We acknowledge that individual circumstances are different and may vary through time. That is why we have applied a “strong plan” framework to our analysis, stress testing these guidelines   to be successful in 9 out of 10 market conditions across a broad range of investment mixes (see below disclosures  for methodology and other key assumptions). Along the way, and particularly as you get closer to retirement, it’s always a good idea to work with a financial advisor to create a retirement income plan.

Disclosure

This information is intended to be educational and is not tailored to the investment needs of any specific investor. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment or action.

The 4 key metrics are calculated based on certain assumption and they are for reference only.

Investment involves risks. Past performance is no guarantee of future results. The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. 

1. The savings factor, savings rate, and withdrawal rate targets are based on simulations based on historical market data. These simulations take into account the returns and volatility that a generic stock/bond/cash asset allocation roll-down variety might experience under different market conditions. Given a set of assumptions for retirement age (65), planning age (94), real wage growth (2%/yr), and net income replacement target (48%), the results were deemed successful when rates of return associated with an 80th percentile outcome during accumulation and a 90th percentile outcome during retirement (decumulation) were applied. The resulting guidelines were consistent across a range of hypothetical asset mixes where the average equity allocation over the full investment horizon was more than 50%. Remember, past performance is no guarantee of future results. Performance returns for actual investments will generally be reduced by fees or expenses not reflected in these hypothetical calculations. Returns may be reduced by taxes where applicable.

2. The income replacement rate is the percentage of pre-retirement income that an individual should target replacing in retirement. The income replacement targets are based on data from Census and Statistics Department (Censtatd) Quarterly Report on General Household Survey 2016, Household Expenditure Survey 2014-15 , and data on Social Security Allowance Scheme from gov.hk. The 48% income replacement target assumes no defined benefit pension income, and Social Security Allowance Scheme (Old Age Allowance) claiming age of 70 without income or assets assessment. For an earlier retirement, this target goes up due to shorter period of pre-retirement investment growth and a long retirement horizon over which expenses must be funded.  Similarly, the target goes down for a later retirement age to account for these factors. For a retirement age of 62, this target is defined as 50% of pre-retirement annual income and for a retirement age of 70, this target is defined as 45% of pre-retirement income. 

3. Fidelity has developed a series of salary multipliers in order to provide participants with one measure of how their current retirement savings might be compared to potential income needs in retirement. The salary multiplier suggested is based solely on your current age. In developing the series of salary multipliers corresponding to age, Fidelity assumed age-based asset allocations consistent with the equity glide path of a typical target date retirement fund, a 20% savings rate (excluding an assumed 10% MPF contribution), a 2% constant real wage growth, a retirement age of 65 and a planning age through 94. The replacement annual income target is defined as 48% of pre-retirement annual income and assumes no defined benefit pension income or other lifetime income sources. This target is based on data from Census and Statistics Department (Censtatd) Quarterly Report on General Household Survey 2016, Household Expenditure Survey 2014-15 , and data on Social Security Allowance Scheme from gov.hk. Fidelity developed the salary multipliers through multiple market simulations based on historical market data, consistent with an assumption of poor market conditions (supporting a 90% confidence level of success).
   
These simulations take into account the returns and volatility that a generic stock/bond/cash “age-based” roll-down might experience under different market conditions. Return and volatility of the stocks, bonds and short-term asset classes is based on the historical annual data from 1934 through the most recent year end available from Bloomberg and Datastream. Stocks (domestic and foreign) are represented by MSCI All Countries World Total Return Index, bonds are represented by Barclay’s Aggregate Total Return Index (Value Hedged (HK$)), and short term are represented by the 3 Month HIBOR rate, respectively.

Portfolios were rebalanced at the end of every month. All calculations are purely hypothetical and a suggested salary multiplier is not a guarantee of future results; it does not reflect the return of any particular investment or take into consideration the composition of a participant’s particular account. The salary multiplier is intended only to be one source of information that may help you assess your retirement income needs. No transaction costs were assumed for rebalancing, nor were any fees included. These costs would reduce portfolio returns. Neither asset allocation nor diversification ensures a profit or guarantees against a loss. All indexes are unmanaged. Performance returns for actual investments will generally be reduced by fees or expenses not reflected in these hypothetical calculations. Returns may be reduced by taxes where applicable.

4. Fidelity’s suggested total pretax savings goal of 20% of annual income (excluding an assumed 10% MPF contribution) is based on our research, which indicates that most people would need to contribute this amount from an assumed starting age of 25 through an assumed retirement age of 65 to potentially support a replacement annual income rate equal to 48% of preretirement annual income (assuming no defined benefit pension income or other lifetime income sources) through age 94. See point 1 for investment growth assumptions. 

5. The probable sustainable withdrawal rate is defined as an inflation-adjusted annual withdrawal rate, and expressed as a percentage of your initial (at retirement) savings balance. This rate is estimated to be 4.1%, assuming a retirement age of 65 and a planning age through 94. See point 1 for investment growth assumptions 

The savings factor, savings rate, and withdrawal rate targets are hypothetical illustrations, do not reflect actual investment results or actual lifetime income, and are not guarantees of future results. Targets do not take into consideration the specific situation of any particular user, the composition of any particular account, or any particular investment or investment strategy. Individual users may need to save more or less than the illustrated targets depending on their retirement age, life expectancy, market conditions, desired retirement lifestyle, and other factors.