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Crafting a successful retirement

03 August 2022 Gareth Stokes

There are three ‘rules of thumb’ that you can share with your clients to ensure they are on track with their retirement savings targets, and a handful of financial behaviours you should warn them about as their retirement date draws near. The 2022 PPS Retirement Summit went beyond the oft-repeated warnings about poor retirement savings outcomes to offer tangible advice for both financial advisers and your clients. Linda Sherlock, Executive Head at PPS Wealth Advisory said building capital and preparing for retirement need not be a daunting experience.

Three rules to retire by…

The first ‘rule of thumb’ is that your clients will need around ZAR1 million for every ZAR5 000,00 in monthly income from a guaranteed life annuity at retirement. So, if your client wants to retire on a gross salary of ZAR30 000,00 they will need to ‘arrive’ at their retirement date with around ZAR6 million. It is important to remind clients that their pension income is derived from the portion of accumulated retirement funding capital that they invest in either a life or living annuity. If, for example, they have plans to withdraw a third of the accumulated capital upon retirement, the maximum allowed by the tax legislation, they will have to adjust their retirement capital target accordingly. 

Pension outcomes from living annuities are slightly different to those achieved in the guaranteed or life annuity space. This is because living annuitants are allowed to decide how much of their accumulated capital to draw down each year, subject to the legislative limits of between 2,5% and 17,5%. “The second ‘rule of thumb’ is that your clients draw down no more than 4% of their capital each year to ensure that the living annuity capital lasts as long as they live,” said Sherlock. “This capital needs to be invested in the right markets, with the right asset allocations and in a multi-managed portfolio that protects your clients against inflation and longevity risks”. 

Budgeting is for life

You clients also need to pay close attention to their monthly expenses. According to Sherlock, financial advisers and planners should encourage clients to do an expense audit as they near retirement. “Your clients should consider their current expenses, take out the items they will no longer be paying for, and add in all the new expenses that are associated with their retirement plan,” she said. Calculating a sustainable pension becomes similar to that of balancing the monthly household budget and involves a close assessment of the income that will be generated from the ‘planned for’ retirement capital versus the expenses that will remain post-retirement. 

The third ‘rule of thumb’ will give your client’s a sense of how much of their gross annual salary they should be putting away towards retirement. Clients who start saving at age 25 will be ok if they tuck away just 15% of their salary; delay until 30 and your client’s savings requirement jumps to 22% of salary; and to 42% of salary if they delay until age 40. “Put differently, your clients should have saved up to three times of their annual salary by age 45; seven times by age 55, and 11 times by age 65,” said Sherlock. Clients should be encouraged to reflect on their savings rate and accumulated retirement capital across both compulsory and discretionary savings vehicles. 

The psychology of money

There are a number of behavioural finance traits that can affect your clients in the planning and draw down stages of retirement, but before you explore these you need a basic understanding of heuristics, which investopedia.com conveniently describes as “a problem-solving method that uses shortcuts to produce good-enough solutions within a limited time”. According to Sherlock, relying on heuristics for decision making in the retirement funding context is risky business. “In retirement planning you need to look at detail, you need to conduct research and you need to understand; so, heuristics work against us,” she said. 

Behavioural finance is an area of study that proposes psychology-based theories to explain financial decision making. There are dozens of behavioural finance constructs, but in retirement planning, your clients should be most concerned with hyperbolic discounting, herd mentality and loss aversion. “Hyperbolic discounting is when you are prepared to give up the long-term good for some form of instant gratification,” said Sherlock. For example, those who opt for higher draw down rates to satisfy their short-term needs face increasing longevity risks. Herd mentality, meanwhile, is used to explain many of the irrational financial decisions that your clients make. In the retirement savings context, herd mentality often exhibits as switching in and out of funds at exactly the wrong time, just because everybody else is doing so. 

Stripping out financial biases

And finally, loss aversion, explains many of your clients’ desires to exit the higher return portions of their portfolios during market downturns. “Many pre-retirees and retirees are extremely cautious, and they end up switching from where they need to be invested into cash or near cash; by doing this your clients are undermining their ability to achieve inflation and longevity protection,” said Sherlock. It is imperative that your clients’ portfolios are appropriately weighted to the asset classes that will produce the required savings outcomes. And you, as the financial adviser, financial planner or wealth adviser need to ensure that the aforementioned financial biases are addressed!

 The presentation closed with a useful checklist to run with your clients at each opportunity. First, as your clients approach retirement, you should monitor their progress towards the needed capital growth. “You must remember that your client’s capital is not necessarily in retirement annuities or pension or provident funds, it could be discretionary capital or tied up in businesses or properties etc,” said Sherlock. At retirement, you must assist your clients to navigate the various choices they have, ensuring that they understand the long-term impact of each decision, including the choice of life versus living annuity; lump sum withdrawals; and annual draw down rates. 

Do the homework, start today…

Finally, you should set up frequent post-retirement financial check-ups to ensure that your clients are informed of the erosion of capital due to draw down rates; the impact of inflation on income; and the return generated by their retirement portfolios, among others. The closing plea to 2022 PPS Retirement Summit attendees was to do the research when it came to their clients’ retirements. This research should not be delayed until 30-days before retirement; but should form part of the retirement planning process throughout the adviser-client journey. 

Writer’s thoughts:
It is easy to make poor decisions about retirement savings, especially when markets are in free fall and cash investments look like the safest bet. How do you prevent clients from making ill-thought or irrational decisions about their retirement capital or portfolios? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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