Why 6% is the magic number to unlocking retirement spending

The fact that a typical Australian retiree dies with 90% of their starting super balance¹ may sound like something to celebrate.

But it means many retirees live in a ‘lifestyle deficit’, doing without goods and
experiences that could make them happier and more comfortable.

That lifestyle deficit rests on three myths about retirement.

3 retirement spending myths

MYTH #1. Retirees should live off their income, not draw on their capital.

MYTH #2. Retirement spending follows a ‘smile’ pattern – high in early, healthy retirement, dipping in the middle years and rising sharply with health and aged care costs later in life.

MYTH #3. Many ordinary Australians face a real risk of running out of money.

Feel free to enjoy yourself

The evidence suggests spending actually declines over the full arc of retirement². The Australian Treasury agrees that spending “tends to fall or remain flat as people age”. This is true across generations and even among higher wealth retirees, “suggesting falls in spending are due to preferences not budget constraints.”

The implications in the Treasury’s Retirement Income Report are clear – most retirees can afford to spend more, especially early on when health and medical conditions are less likely to slow them down³.

“The evidence indicates that retirees tend to hold on to their assets and leave significant bequests, even though surveys suggest people do not prioritise leaving a bequest. If people drew down more on their assets, they could have a higher standard of living in retirement⁴.”

How to deliver a higher cashflow in retirement

AMP General Manager, Retirement Solutions Ben Hillier believes the current 4% rule of thumb for retirement drawdowns is no longer adequate⁵.

“The 4% number is a very expensive form of longevity self-insurance,” says Ben.

The good news is a combination of growth-focused investing, good advice and the flexibility of lifetime income streams can deliver higher cashflows in retirement.

Retirees can enjoy a better lifestyle by drawing down closer to 6% of their income a year by:

• assuming their real spending will decline by between 1-3% a year in retirement – less than inflation. Real income will also slowly fall, but they won’t face the shock of their monthly payments reducing.
• maintaining a moderate-to-high allocation to growth assets.
• allocating around 50% of retirement capital to a market-linked lifetime income stream, with the balance in an account-based pension.

A market-linked lifetime income stream delivers crucial benefits. The income is guaranteed to death – but the amount is variable. Capital withdrawals are restricted. And because the product provides a variable return, there’s no need to reserve or invest conservatively.

“There’s no point in just telling people they can afford to spend more money,” says Ben. “That butts up against a set of quite understandable conservative biases. We need to offer them comfort they won’t sacrifice long-term financial security for a short-term spending kick. This 6% rule-of-thumb does that. It leverages the power of compounding large sums at market rates. It takes a realistic view of retirement spending patterns.

“And the strategy is even more attractive when you consider many Australian retirees have some form of contingency if markets move sharply against the strategy – either inherited wealth, housing equity or some access to welfare. With the enhanced age pension access that a lifetime income stream can provide, it looks even more attractive.”

AMP’s guide to retirement income

This is an edited chapter from Retire with Confidence – AMP’s guide to the new world of retirement income. If you’d like to read more, download the full paper here.

¹ Retirement Income Review. Australian Treasury. July 2020.

² Exploring the Retirement Consumption Puzzle, David Blanchett, 2019.

³ The RIR suggests many people overestimate the impact of health costs in late retirement. Health spending remains a relatively small share of total expenses in retirement. This is largely due to public expenditure on health absorbing much of the cost of ageing.

⁴ Retirement Income Review. Australian Treasury. July 2020.

⁵ 6% is the New 4%. How market-linked lifetime income streams can rewrite the retirement planning rule-of-thumb book. Ben Hillier, AMP, 2023.