One of the big questions about saving for retirement is, how much do I need?
Retirement is probably the last thing on your mind when you start work and earn an income for the first time. It is something that is about 40 years away.
But those 40 years translate into a mere 480 paydays. From those 480 pay cheques, you have to save enough money to live on from the day you stop working until the day you die. If you live the high life when you are young, without saving, you cannot expect to retire wealthy.
For most people, retirement savings amount to their single-biggest investment - far more money than the total of all their other assets. Your retirement savings, however, may not be enough, even if you start saving early and do not draw down on those savings along the way.
Most employer-sponsored retirement funds are based on you receiving a pension of about 70 percent of your final annual pensionable salary (excluding motor vehicle allowances and other non-pensionable income). This means you have to top up your retirement savings with additional savings.
Assessing how much money you need in retirement is difficult, particularly when you are young.
The simplistic answer to the questions of how much you need to save for retirement, and how much capital you need on the day you stop working to ensure a financially secure retirement is: As much as possible.
In assessing how much money you need for retirement, you need to ask yourself two questions:
1. "How?" You need to ask yourself a number of questions in this regard, of which the most important is, "What lifestyle do I want in retirement?" This ranges from how you intend to live and where you intend to live.
Once you have decided on the lifestyle you want and how much it will cost, you need to work backwards to establish how much you need to save and how long it will take to save the required amount of capital.
2. "When?" You need to set a retirement date. Affordability, based on the lifestyle you want at retirement, is the most important factor in deciding when to retire.
The choice of when you retire, however, may not always be yours. If you are a member of an employer-sponsored retirement fund, the date will probably be set for you. Disability or forced early retirement could also upset your plans.
The two big problems you face in planning a financially secure retirement are the "retirement gap" and inflation.
1. Mind the gap
The retirement gap is the difference between what you have saved by your retirement date and the amount you need to retire financially secure.
Most people only wake up to the retirement gap when they are a few years from retirement and start calculating how much they need at that stage. In most cases it is too late.
The table shows how much of your income you need to save to be able to retire with 75 percent of your final annual salary, assuming a real (after-inflation) investment growth of three percent (on top of salary growth) and current pension rates. Different age starting points to targeted retirement age are provided.
Quite frightening!
2. Mind the value
Your second enemy is inflation, both in the build-up stages, but more particularly in retirement.
While it is clear that you need to start saving early, you also need to be sure you are accumulating your retirement wealth at a rate that is greater than inflation. In simple terms, this means that the R1 you receive and spend today will not be worth R1 ten years from now.
The effect of inflation not only determines how much you need to save, but also the investment strategies you need to follow, both while building up your retirement savings and during retirement.
If, say, you invested R1 000 a month in your retirement plan for 40 years, you would have saved R480 000. If you received an average return of eight percent a year, you would have a capital lump sum of R3 514 281. But if, over the same period, the average inflation rate was 10 percent, the buying power of your money would be worth R77 648 (after deducting inflation). In other words, this is the value of the money you would have saved in 40 years.
An inflation rate of 7.2 percent means the purchasing power of your rand will halve every 10 years.
Obviously, however, you will also be increasing your contributions in line with inflation, but these calculations underscore the importance of beating inflation with the returns on your money as well.
Now let's look at what happens in retirement. Let's assume you purchase a level monthly pension of R10 000 a month. In 10 years' time, assuming an inflation rate of six percent, the buying power of your pension will reduce to R5 583; in 20 years to R3 118; and in 30 years to R1 741.
The need for a plan
The best way to calculate how much you need for retirement, how much you should be saving for retirement, and how soon or late you can retire, is to have a properly qualified financial adviser analyse your overall financial position. The process is called a financial needs analysis.
A financial needs analysis, also known as a fact find, does a number of things for you:
- It identifies how much money you need for retirement and other financial goals;
- It identifies the needs of your dependants if you are no longer able to provide for them;
- It identifies how you should structure your medium- to long-term financial plans;
- It clarifies your lifestyle goals;
- It tells you what you can afford and what you cannot; and
- It often gives you a wake-up call. It is a reality check.
In the case of retirement planning, a financial needs analysis can be used:
- In the build-up stages to establish how much you need and to ensure you are on course;
- In the final lap to plan your retirement structures; and
- In retirement to fine-tune your plans to ensure you don't outlive your savings.
Your retirement savings strategy must form part of your overall financial plan and not be implemented in isolation. You must establish all your financial goals. You have to decide on all the important things in life that will cost you money, such as educating children, buying a home and, importantly, how you want to live once you retire. You need to balance all your needs if you are to get your retirement planning right.
Your personal circumstances are a major issue to consider when planning for retirement. These circumstances include:
- Age. How far you are from retirement, when you expect to retire, and how long you can expect to live in retirement. Average life expectancy is about 77 for low-risk men and 83 for women. But remember, these are averages. You could live for much longer, meaning you will need more money to support yourself.
- Earnings. It is not only about how much you earn, but also about how much you can save and how much you will spend in retirement.
- Accumulated wealth. The more you have accumulated, the sooner you will be able to retire.
- Debts. You need to take account particularly of long-term debt, such as a home loan. You do not want to go into retirement with debt.
- Dependants. People who depend on you for financial survival will have an impact on your plans, both now and in the future.
- Health. Can you be sure you will be as fit tomorrow as you are today?
- Lifestyle. Are you prepared to eat jam sandwiches and not caviar?
- Risk. The level of risk you are prepared to take when investing your retirement savings.
- Tax. Tax structures have an impact on all stages of retirement planning.
- Where. The place where you want to live will also affect your retirement plans. There are big differences between an apartment in Hillbrow and one at Clifton beach.
A financial needs analysis is not a once-off event. You must constantly revisit your financial and retirement strategies to ensure your are on track.
Next week:
How to plan for retirement at different stages of your working life