Ashley Percival, CFP®
It is no secret that medical advances allow us to experience greater longevity. According to David Sinclair, co-director of a lab on aging at Harvard Medical School, the first person to live to 150 has already been born. Incredible, indeed!
Although living longer has a number of personal benefits, it is not without consequence. Greater longevity means that our retirement is going to last longer and there will be increased chances that other forms of risk will manifest. For example, there is more time for another financial crisis, more time for inflation to compound and increased chances for an expensive health problem. The list goes on.
When retired we all want to maintain a suitable standard of living for the remainder of one’s life. Current projections are that for each extra year spent in retirement, we need to accumulate approximately 5% more capital. In other words, an extra 10 years spent in retirement will require about 50% more capital. This is a scary figure, which highlights the importance of retirement planning.
Preparing for [longer] retirement
Research indicates that most individuals have never done a retirement needs assessment. In other words, they have not figured out how much money is needed to retire let alone how much they need to put away each month to reach retirement goals.
Although the importance of a proper retirement needs analysis cannot be overstated, it should be noted that this exercise is by no means an exact science. One of the primary difficulties of retirement planning centres around the fact that so many assumptions have to be made. Apart from longevity, these assumptions include:
The rate of inflation can have a huge effect on a retiree’s standard of living as it erodes the buying power of income that, in large part, may be fixed. A realistic projection of future inflation rates is needed to calculate the income and assets needed to retire.
According to Stats SA, the current annual inflation rate is 6.3%. The long term inflation rate is closer to 10% per annum. Using the rule of 72, you can estimate how long it is going to take for the value of your money to halve by dividing 72 by expected annual inflation. Assuming the rate of inflation is going to be 8% per annum, the value of R1 will have the buying power of 50 cents after 9 years. Of course, this is just an estimation as the rate of inflation fluctuates and does not remain static every year.
The type of lifestyle an individual or couple seeks to live in retirement will greatly affect the level of retirement assets and income needed. Factors to consider are travel plans, housing, hobbies, part-time employment plans etc.
Return on retirement capital
The rate of return an investor will earn on retirement capital also requires assumptions about the unknown. Typically, planners will rely on historic rates of return for various types of portfolios when drawing up a retirement plan.
To err on the side of caution, financial planners use conservative estimates that may be a couple percentage points below historic rates of return. As an example, over the long run, South African growth assets such as listed shares produced a real rate of return in the 6%-7% range. A financial planner might use an estimate real return of about 3%-4% per annum for this asset class.
How much income can I draw during retirement?
The 4% rule
The 4% rule is often presented as a virtually fail-safe strategy to ensure sure you don’t run out of savings during retirement. According to this rule, you withdraw 4% of your retirement savings during the first year of retirement, increase that income amount each year by inflation to preserve your purchasing power, and you have an 80% to 90% assurance that your savings will last at least 30 years. So for example, if you need a pre-tax income of R400 000 per annum, you need R10 Million retirement capital.
The problem with this rule is that life isn’t so easy and exact. Any number of unforeseen events over which you have no control over can wreak derail any well thought out plan. That being said, the 4% rule doesn’t make a bad starting point.
Insufficient provision for retirement
Damn, you are going to live longer in retirement and it is clear that you have insufficient capital to retire at your planned age. Although this is a reality confronting most South Africans, it certainly does not mean nothing can be done. The following are practical things you can do to alleviate the situation:[i]
- The first and obvious thing to do is to start putting money aside right this minute. Even if the money you think you can afford to save is relatively low. Just putting some money away towards your retirement is a step in the right direction.
- If the amount that you are putting aside is not sufficient to fund your retirement needs, you need to start thinking of ways to cut your expenses so that you can add more to your retirement savings. You might have to consider selling your house and live someplace cheaper, trade your car for something more affordable, cutting memberships or subscriptions that you’re not using, reducing the amount of times that you eat out every month etc.
- Plan on working longer. The difference between how much you have saved to retire at 65 and the amount needed if you wait until you are 70 can be enormous. It is not a bad idea to obtain skills that you need to stay in demand and employable. You might want to consider starting a small business. Apart from the extra income, starting your own business gives purpose to your life and keeps your mind sharp.
- Get professional help. When it comes to retirement planning, it can feel awfully intimidating trying to navigate the options. I good financial advisor will help you to put a workable plan in place and encourage you to stick to your plan. Your financial advisor will also regularly review your plan and will adjust assumptions made where necessary.
What not to do
The biggest mistake individuals make when attempting to make up for lost ground is to chase unrealistic returns. Individuals then become easy targets for unscrupulous conmen who persuade them to invest their hard earned money in unregulated and/or illegal schemes. By the time investors realise that something is amiss, initiators of the scheme are nowhere to be found, have a ton of excuses or cunningly shift the blame. More often than not, investors lose all of their retirement capital.
Living longer is a reality; you need to start saving towards retirement as soon as possible. Don’t gamble with your life savings, invest with reputable financial services providers.