If you want to retire comfortably you must...

Gareth Stokes, FAnews Online Editor

Volumes have been written on the subject of retirement. Financial journalists and media liaison officers at various financial services providers and industry bodies have churned out dozens of columns on the sensitive topic. The idea is to create an awareness of the challenges every South African faces at retirement. Professional financial planners and intermediaries have their work cut out too. They spend hundreds of hours in close consultation with their clients to ensure sufficient capital is available at retirement.

The ‘big idea’ in retirement planning is to ensure you have enough capital at retirement to satisfy your living standard requirements until death. How do you determine this capital amount? Aside from the obvious ‘first steps’ in financial planning, most experts begin the ‘capital required’ debate by determining an appropriate replacement ratio. They ask clients to sit down and decide how much of their final gross salary prior to retirement they will comfortably survive on in their first year after retirement. This replacement ratio isn’t the same for everyone, but the industry deems a replacement ratio of 75% in the first year, with inflation adjustments each year thereafter until death, to be sensible for a comfortable retirement.

Bring on the number crunchers

Armed with an appropriate replacement ratio – and sensible inflation and return expectations – financial planners can estimate the capital lump sum required on retirement. Today’s newsletter isn’t going to get too technical. We’re quite happy to leave the complicated present value of annuity calculations to the actuaries. Our basic attempt to answer the ‘can you afford to retire’ debate includes an assumption that your first day of retirement is tomorrow. How much capital would you need?

It’s dangerous to assume things in the world of financial planning and investment, but we don’t have much choice. For this exercise we’ll assume inflation of around 6%, an annual gross final salary of R240 000 per annum and a replacement ratio of 75%. Our subject is retiring tomorrow and can survive comfortably on R15, 000 per month. Peter Doyle, President of the Actuarial Society of South Africa, answers the question: “How much do I need to save for my retirement?” with another question. How likely are you to have R6 million in savings and investments at your disposal? That’s how much you would need – tomorrow – if you hoped to generate R15 000 per month without eating into your available capital.

Of course the capital preservation theory isn’t going to feature in too many retirement plans. The optimum solution would require this capital amount to be depleted to almost zero at death. The typical retiree purchases an annuity to provide this monthly income to death, with current regulation allowing for an annual ‘salary’ drawdown on the annuity capital of between 2.5% and 17.5%.

More simple retirement calculators

The ‘rule of thumb’ is you need 12 times your annual salary to buy a financially comfortable retirement – assuming you’re debt free and single. You need to bump up this amount to 15 times if you have a spouse. Doyle observes: “If you currently earn R1 million a year, you will need around R12-million when you retire. With an annual real return of 3% you will be able to draw an income of R30 000 per month (before tax) and keep pace with inflation for a very long time.” You’d need R1.5 million to ensure access to R3 750 per month on an ongoing basis.

Doyle warned against factoring your house into the retirement equation: “You’re fooling yourself with this approach, because you will still need to stay somewhere once you have retired! We’ve heard similar warnings in recent months – with one financial adviser observing the technical difficulties in downsizing properties at or during retirement. People think they can convert their family home into a smaller retirement property and pocket a few hundred thousand rand in change. Instead they’re lucky to find a smaller property for the same money!

Living for the moment

Too many South Africans live for the moment, passing the opportunity to save in favour of funding their immediate lifestyle needs. Because consumers don’t have the discipline required to independently implement long-term financial plans it’s essential they consult with a qualified financial adviser. The financial services industry tries to drill this message home during one month each year. But the message needs to be drilled into our conscious 24/7 365 days a year! “It’s important that we provide consumers with an indication of what their long-term savings goals should be,” says Doyle.

The harsh reality is local consumers are saving far too little to achieve even the most basic living standard through retirement. It’s a shortcoming that exhibits across the country’s three ‘savings’ pillars. South Africa’s households (you and I), corporations and government save approximately 15% of gross domestic product (GDP) each year, while countries like China, India and Turkey save in excess of 30%! But the real shocker is local households only manage 1.5% of GDP at present. The focus on survival means most households don’t even have an emergency lump sum saved up!

Forgot short-term gratification – the goal should be to secure a comfortable retirement. Doyle observes: Each and every employed person should make saving for retirement their top financial planning priority. Today’s new car, mansion and brand-name wardrobe won’t keep the refrigerator stocked through retirement!

Editor’s thoughts: Retiring at 55 or 60 years is a thing of the past. South Africa’s grim savings statistics mean we’re going to have to work until age 65 or older. This trend is already establishing throughout the Euro-zone, where governments are trying to cut expenditure by increasing the mandatory retirement age closer to 70. Would you be comfortable working until age 70? Add your comment below, or send it to gareth@fanews.co.za