When does work become optional?

Work becomes optional when income from passive sources (such as investment income, annuities or pensions) is sufficient to meet your anticipated living expenses.

Many people do not wish to retire however they do want the “peace of mind” that comes with getting to the point where they could afford to retire if they chose to do so. In fact many people continue to work well past the age of 65 (perhaps a reduced level) as they enjoy the challenges and opportunities presented by the workplace. 

And of course, maintaining an income from work activities also assists in creating a valuable cash flow.

We are often asked by clients, how much money do they need to retire? While this may be viewed as a simple question the answer is often complex.

How much do you expect to spend? How long do you expect to live? Do you wish to leave funds for the benefit of your dependants via your Estate? As the answer to how long someone may live is rarely known it is very difficult to plan the spending of one’s capital.

You do not want to be in the position where your capital runs out before you do!

Accordingly the most comfortable financial position is where the income from passive sources is sufficient to meet your living expenses. As in the earlier part of one’s life ongoing savings is also desirable. Being in such a position means that you are not spending your capital but simply living on the income.

Sources of passive income

Some investors may be entitled to receive a Superannuation Pension funded from their retirement savings. Such pensions are usually guaranteed for life and, in the event of death, a portion of the pension will continue to be paid to their spouse. Such pensions do not generally have a capital value. It is also possible to purchase annuities from life insurance companies to provide a guaranteed income stream – either for your lifetime or for a fixed period.

It is also possible that individuals may be entitled to an Age Pension entitlement (which is means tested) – once again a secure income stream. There are also additional benefits attached to an Age Pension.

Fixed interest income is subject to prevailing interest rates. Over the past 10 years interest rates have varied substantially. If you relied solely on fixed interest income to fund living expenses the level of income being provided from one year to the next would have changed significantly during this period.

Dividends from a portfolio on listed shares are generally quite stable. As the dividend payable is reliant on the profitability of the company they can vary from one year to the next. However a diversified portfolio of shares will usually provide opportunity for variations in the dividend of one company being offset by variations in the dividends of another. Historically dividends have been an “increasing” income stream over time.

Furthermore Australian shares often carry Franking Credits. These credits are tax credits for tax previously paid by a company. The intention is to eliminate the double taxation of company profits – once at the company level and again at the shareholder level. Franking Credits provide a 30% tax credit for the company tax already paid. This can result in tax refunds or a reduced tax liability.

Rental income from property based investments (either directly held or indirectly via a trust) also provide a source of “increasing” income over time. Once again a diversified portfolio of property investments (including infrastructure assets) will assist to provide a reasonably stable source of income.

To minimise risk (or conversely to increase the reliability of income streams) income should be obtained from a variety of sources across the various asset classes. The mix of income in terms of how much is allocated to each sector is a matter that needs to be considered relative to the particular needs of each investor.

February 2013