How to calculate the net worth you need for financial freedom

Want to retire rich or young? Step one is calculating how much wealth you should build and navigate to be financially free.

Net worth is a number that’s quite easy to calculate, but it’s much more difficult to work out what wealth you need to be financially free.

While people can determine their net worth by deducting total debts from total assets, there are varying estimates and resources available to project what’s necessary for a comfortable retirement.

The Association of Superannuation Funds of Australia says a single homeowner would need $545,000 at retirement to live comfortably on $47,383 a year, while a couple would need $640,000 to live on $66,725, with both relying on a mix of their own assets and age pension payments.

Super Consumers Australia says a single middle-income homeowner would need $301,000 at age 65 to deliver annual income of $44,000, while a high-income single homeowner needs $745,000 for annual income of $55,000. It says couples will need $402,000 for a middle income of $64,000 a year, while a high-income retirement delivering $81,000 a year will require $1 million of assets.

Early retirement is a tougher ask, because without a pension the asset requirements are higher, but financial planners often see people who could have retired sooner but believed they did not have enough wealth.

SIMPLE ANSWER

In his new book Money Magnet, chartered accountant and investor Steve McKnight says a plan that relies on the age pension “and leading to a life lived below the poverty line is surely a poor plan”.

Steve McKnight says if you do what everyone else does, you get what everyone else does.

He says peoples’ busy lives force them to focus on today rather than tomorrow, leaving it too late for many to accumulate enough for their desired lifestyle, but there are ways to work out the steps to financial freedom.

“A simple answer is 80 per cent of what you earned before you retired. This assumes that your living standard equals what you used to earn, but scaled back because you won’t have work expenses,” McKnight says.

“You can calculate your own number … nominate your desired annual income, divide it by your expected return and arrive at the amount of investment capital you’ll need. If you wanted an annual income of $60,000 and believed you could achieve an 8 per cent return, then you’d need $750,000.”

“Alternatively, you could aim higher, say $100,000 per annum regardless of whether you’re a single or a couple.” This would require $1.25 million of investments not including the family home, “placing you among the richest retirees in the country”.

“If you do what everyone else does, then you’ll get what everyone else has.”

FREE CALCULATORS

Moneysmart.gov.au, superannuation funds and financial institutions have free online calculators that can help people with projections. It pays to spend time on these, before seeking professional advice to help build a big nest egg.

Perks Private Wealth director Simon Wotherspoon says financial freedom is about “being able to spend your time on your own terms”.

“You might still work, or you might volunteer, or you might spend your time sitting on the beach,” he says.

“Over the years, I’ve found that regardless of someone’s wealth position, most people find it difficult to readily understand how much wealth they need to be financially free.”

Wotherspoon suggests you will need 70 per cent of your pre-retirement income, assuming you can structure your savings to be tax-effective, and says there are many considerations to make when calculating the assets needed.

“A useful rule of thumb is to divide your retirement income need by 5 per cent. So, if you’d like to have a retirement income of $200,000 per annum, then you might need around $4 million, as a guide,” he says.

Financial freedom is about spending your time on your own terms.

MBA Financial Strategists director Darren James says financial freedom means different things to different people, but for him it’s “the day when you are waking up and going to work because you want to, not because you have to”.

James says he sees fewer people retiring “cold turkey” nowadays as many older people mix part-time work with lifestyle flexibility, and he prefers calculations using conservative estimates of investment returns around 3-5 per cent.

“I’ve never seen anyone complain because they end up with too much money,” he says.

TOOLS TO HELP

• Compound interest calculator: how investments grow.

• Retirement calculator: find out your income when you retire.

• Superannuation calculator: your super balance at retirement.

• Account based pension calculator: how long your super pension will last.

Source: Moneysmart.gov.au

Originally published as How to calculate the net worth you need for financial freedom