The fifteen percent retirement myth
There are many “numbers” the financial services industry accepts as fact. Short-term insurers believe two thirds of the country’s vehicles are uninsured. Retirement planners reckon only six out of every 100 citizens will save enough to enjoy full financial independence through retirement. And the retirement funding industry parades 15% as the magic monthly contribution to “guarantee’ this independence. John Williams of The Retirement Planning Bureau summarises the long held view: “It’s often reported that if a person saves 15 % of their earnings over a working lifetime (say 35 years) they will be able to retire in style.” But the assumption doesn’t always hold. “This is a useless and unhelpful bit of actuarial rhetoric, because it rarely, if ever, pans out that way,” he says.
One of the biggest problems facing the so-called 15-percenters is how much of their monthly contribution actually goes to retirement funding. Williams says the reality is most group schemes allow for deductions to death and disability benefits which become progressively more expensive as the employee gets older. Over the 35 years a decreasing portion of the 15% “pension fund” contribution actually makes it to the retirement funding pot. So you might be contributing 12.5% when you begin saving only for this to taper off to 10% or less in the years pre-retirement. Why has the industry cast the 15% gross saving number in stone?
Forget the bullets and focus on the target
The financial media is party to blame. At the industry’s behest we’ve repeatedly touted this number as the optimal long-term retirement fund contribution. I’ve been to dozens of retirement funding presentations and cannot recall one where “15% over 35 years with full preservation” wasn’t trotted out as the retirement funding “cure all”. The South African Revenue Services (SARS) have played their part in perpetuating the 15% myth too. “The law allows someone who is not in retirement funding employment – not a member of an employers’ retirement fund – to contribute, as a tax deductible payment, 15% of their non-pension earnings into a retirement annuity,” notes Williams. We believe 15% is enough because everyone tells us it is, and because SARS gives us zero benefit for saving more...
But we’ve become so obsessed with the retirement savings mechanisms (our monthly retirement contributions and financial instruments used to squeeze out market-beating return) that we’ve lost sight of the retirement savings goal (the target). Instead of focusing on the magical 15% monthly contribution we should be setting ourselves a savings target – an amount of capital we hope to accumulate upon retirement – sufficient to meet both capital and income needs. The foundation for any successful retirement plan is for the individual to know their desired income and capital upon retirement!
There’s no quick fix for your retirement plan. Your success depends on the correct mix of just three factors: time, rate of savings and return spot on. The only way to increase the amount of capital available to you upon retirement is to “improve” one or more of these factors. You can begin saving earlier (more time in the market), save more (increase your monthly retirement funding contribution beyond the accepted 15%) or generate better returns. Two of these factors are entirely in your own hands – to rely on improved market returns to make up your retirement funding shortfall is nothing short of financial suicide.
Easy calculation – tricky variables
Because time to retirement is generally a given (how many years until you’re 65) it’s quite easy to calculate the monthly savings rate required to deliver a predetermined capital outcome. The tricky part is making sure you plug in reasonable estimates of investment return and inflation. Upon completing this exercise – erring on the side of caution where return and inflation forecasts are concerned – you’ll soon discover the 15% requirement is a total myth. In William’s experience the actual contribution required comes in somewhat above the “accepted” standard.
A comfortable retirement requires a changed mindset. “Most present day retirement planning is based upon what a person is prepared to invest rather than on what they need to invest,” opines Williams. “Small wonder then, that so many suffer a significant financial shock at retirement!”
Editor’s thoughts: I like John William’s “target focus” when it comes to retirement planning. It makes sense that the capital required upon retirement is the primary focus, and that we calculate a sensible monthly contribution based on that target rather than industry say so... Are you one of the 15-percenters mentioned in the story – and do you think you’re saving enough for retirement?Add your comment below, or send it to [email protected]
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