Think of retiring on your first day of work

“Only 6% of South Africans have enough savings to retire comfortably”

As you start your first job, retiring is probably the last thing on your mind. Yet many issues facing the retirement industry stem from poor decisions made now. Most employees sign retirement fund forms without receiving financial advice and then proceed to ignore this investment. They do not know what replacement ratio to target. In fact, many have never heard of replacement ratios.

Joe Karabus, Senior Business Development Manager at Momentum Employee Benefits Corporate, explains: "A replacement ratio projects what percentage of your final monthly income you will have as post-retirement income. So, if your monthly income pre-retirement is R10000 and you have a 60% replacement ratio, you will have a monthly post-retirement income of R6000.”

"Studies show only 6% of South Africans have enough savings to retire comfortably and only 30% of pensioners have enough capital to last the rest of their lives. Government's retirement fund reform targets a replacement ratio of 40%. Although this is inadequate, it's higher than South Africa's current replacement ratio of 13-15%. Ideally investors should target a 70 – 80% replacement ratio.”

Karabus warns: "When assessing replacement ratios, it is equally important to review future death cover and disability needs. Typically, a member's age reflects his life stage, number of dependents and expenses. This peaks at around age 35, where an insurance replacement ratio of 11-12 times annual salary is required. Few people at this age have this level of cover, with the average of 3-5 times. One can circumvent this insurance gap if the fund allows the choice of higher cover at a young age.”

Karabus believes it is vital to understand the assumptions underlying replacement ratios. These include an annual inflation-based salary increase, a set contribution rate, inflation, investment real net returns of 4-6%, preservation of the investment when changing jobs and choice of annuity. Review these assumptions and your targeted replacement ratio regularly and adjust where necessary to remain relevant.

"If you want to live comfortably in retirement and take the odd overseas holiday, you need to start saving early and target a hefty replacement ratio. The secret is to maximise your replacement ratio. Structure your remuneration package to increase your pensionable salary and raise your contribution rate. An early contribution increase of 2-3% translates to an additional 15-17% in monthly income at retirement. Whenever possible, make additional voluntary contributions. A higher replacement ratio will also provide a buffer against negative factors like increased tax and high inflation.”

Preservation is vital to maximise your replacement ratio, yet Karabus is concerned that too many people cash in their retirement savings when changing jobs. Similarly, at retirement he advises you limit the lump sum portion of your benefit.

Karabus offer some final advice: "Think retirement from your very first paycheck. Seek professional financial advice and review your replacement ratio regularly. Fund benefit statements often specify your current replacement ratio. Some even show a red, amber or green symbol to indicate your progress in targeting your replacement ratio. Always aim for green!”