The importance of the 10/30/60 Rule to your retirement income

It’s tough working out how to build a solid retirement income. 

There are a lot of moving parts. It’s essential to understand where your money is likely to come from and how you can build on what you’ve already saved.

To add perspective to your thinking, a simple ‘rule of thumb’ about retirement income might assist you.

Where does your retirement income come from?

Research first undertaken in the United States some 30 years ago is still relevant for Australian super fund members today. It found for most people, around 90 cents of every dollar in retirement income comes from the earnings you achieve on your investments before and after retirement. Just 10 cents of each dollar of retirement income comes from the original contributions you made during your working life.

More surprisingly, around 60 cents in every dollar of retirement income comes from the investment earnings you achieve after you retire.

Jim Hennington, actuary at Jubilacion, has tested these calculations and adapted them for Australia’s superannuation system today (see below). He confirms the principles are still very relevant to Australians.

Although the actual percentages for each person will vary depending on their personal situation and the market conditions they live through, the principles are highly relevant to the way most people’s superannuation works over the course of their lifetime.

The practical implication is that earning a good investment return on your retirement savings is just as important, if not more important, than it was during your working life.

It’s all to do with the way investment returns work over the long term, and the impact of compound interest.

Does the 10/30/60 Rule apply to Australian retirees?

Hennington’s calculations for Australia assume the person joins a super fund at age 25 and contributes $7,000 per year (before contribution tax) with this amount rising 3.5% every year until retirement at age 67. They then begin drawing a retirement income that increases by 2.5% per year. The amount they draw gets calculated so their balance is zero when they reach age 92. While working, the assumed investment return is 6.5% per year (net of tax) less fees and charges of 0.7% per year. In retirement, the assumed return remains at 6.5% per year (assuming slightly more conservative investments but no tax) less fees and charges of 0.7%.

In Australia, based on these assumptions, their balance, contributions and net investment income look as follows:

Age	Contributions $ per yr  after 15% tax	Start of year $ balance	Investment income $ per year	Drawings $
25	5,950	–
26	6,158	6,127	177
27	6,374	12,840	554
28	6,597	20,180	967
29	6,828	28,195	1,418
30	7,067	36,932	1,909
31	7,314	46,444	2,445
32	7,570	56,786	3,028
33	7,835	68,017	3,661
34	8,109	80,200	4,349
35	8,393	93,403	5,094
36	8,687	107,698	5,901
37	8,991	123,159	6,775
38	9,306	139,869	7,719
39	9,631	157,914	8,739
40	9,968	177,386	9,841
41	10,317	198,383	11,029
42	10,678	221,010	12,310
43	11,052	245,378	13,689
44	11,439	271,605	15,175
45	11,839	299,817	16,773
46	12,254	330,148	18,492
47	12,682	362,740	20,339
48	13,126	397,747	22,324
49	13,586	435,328	24,455
50	14,061	475,656	26,742
51	14,553	518,914	29,196
52	15,063	565,295	31,828
53	15,590	615,007	34,649
54	16,136	668,270	37,673
55	16,700	725,317	40,911
56	17,285	786,397	44,379
57	17,890	851,774	48,092
58	18,516	921,729	52,066
59	19,164	996,562	56,317
60	19,835	1,076,589	60,863
61	20,529	1,162,149	65,725
62	21,248	1,253,600	70,922
63	21,991	1,351,324	76,476
64	22,761	1,455,726	82,411
65	23,558	1,567,236	88,750
66	24,382	1,686,314	95,520
67		1,813,445	102,749	105,924
68		1,810,826	103,305	108,572
69		1,805,240	102,986	111,286
70		1,796,438	102,484	114,069
71		1,784,153	101,783	116,920
72		1,768,100	100,868	119,843
73		1,747,976	99,720	122,839
74		1,723,458	98,321	125,910
75		1,694,199	96,652	129,058
76		1,659,832	94,691	132,285
77		1,619,964	92,417	135,592
78		1,574,177	89,805	138,981
79		1,522,025	86,829	142,456
80		1,463,032	83,464	146,017
81		1,396,695	79,679	149,668
82		1,322,472	75,445	153,410
83		1,239,791	70,728	157,245
84		1,148,040	65,494	161,176
85		1,046,569	59,705	165,205
86		934,686	53,323	169,335
87		811,655	46,304	173,569
88		676,690	38,604	177,908
89		528,959	30,176	182,356
90		367,572	20,969	186,915
91		191,587	10,930	191,587
92		0	0

If we focus on what happens in retirement, the sum of future drawings from age 67 (that is, the sum of the right-hand column of the table) was $3,618,127.

Slightly over half of this (50.1%) came from the balance they had at age 67 (which was $1,813,445) and the rest (49.9%) came from summing their investment returns after age 67 ($1,804,682).

In other words, half of their retirement income comes from investment returns after they’ve retired. Only half of their retirement income came from drawing down the balance they held at age 67.

Why do investment returns play such a big role?

Basically, as your balance grows, investment returns become a major source of cashflow. By age 41, the investment income in the above table is more than the contribution level. Most people’s super reaches a peak when they retire and start drawing money out for retirement. Depending on how much they draw each year, the balance often remains high, long into retirement.  

In the retirement phase, the maths is working in a similar way to when you make standard payments on a mortgage over the 20-year or 25-year term of your home loan. During the early years, your mortgage payments consist mainly of interest – as the balance owing is high. Towards the end of the loan, as the balance owning reduces, your mortgage payments consist mainly of capital repayments.

It’s similar in retirement, your drawdowns in the early stages consist mainly of investment returns on your balance. Whereas later in retirement, as your balance reduces, your drawings mainly consist of the capital itself.

Risk and uncertainty

The above calculations are all based on fixed assumptions. This is a limitation of using simple projection models for retirement. The calculations assume a known ‘run out age’ and fixed rates of growth for investment returns and salary increases. In reality, none of these are known with certainty at all!

Retirees don’t know what future returns they will get. Nor do they know how long they will live. This means they cannot determine how much they can draw from super with any certainty. Depending on these factors, and the risk of negative returns close to retirement, the amount of drawings your super can sustain in retirement varies dramatically.

Nonetheless, instead of moving all your money into cash, which drastically reduces your investment income prospects, modern retirement models can take into account the probability of all possible outcomes. This means you can find out the level of retirement spending that you can enjoy with, say, 95% confidence that it’s sustainable for life – even if you live a long time, market returns aren’t favourable or living costs increase.

Conclusion: What does this mean for retirees?

Although choosing the right investment option or mix of assets for your super account is important during your working life, the above ‘rules of thumb’ show it is just as important in retirement.

As a retiree, you need to keep investing your nest egg throughout your retirement years with a carefully considered strategy balancing security, investment risk and good investment returns.

If you retire in your 60s, you might be in retirement for 20–30 years, and that means you need to take a longer-term view of your investments. You may wish to consider taking on some investment risk with at least part of your retirement savings with the aim of generating solid returns.

By including some growth assets (broadly shares and property) in your portfolio to provide enhanced returns, you may be able to defer the need to draw heavily on your capital amount.

History has shown growth assets usually have a better chance of delivering the good returns needed to fund your retirement income, even if you are drawing down on them at the same time. Modern modelling techniques help to trade off risk (running out of money) and return (a higher lifestyle or other goals) in the retirement phase. 

The modelling for this article was kindly provided by Jim Hennington, qualified actuary. Jim is co-founder of Jubilacion who provide an expert retirement modelling service for individuals. Jubilacion’s software helps people design retirement plans that take risk into account, based on their circumstances, decisions and goals.