Ask anyone in formal employment who is within 15 years of retirement about their biggest asset. The likely responses are “my house,” “my farm,” or perhaps even “my car.” Yet, few realise that banks and finance houses often hold a larger stake in these so-called assets than the registered owners themselves.
The truly savvy might answer, “My savings and pension money,” and the exceptionally astute may add, “My ability to earn an income.” These individuals, often with guidance from a competent financial adviser, understand the importance of insuring this invaluable asset through life, disability, and severe illness coverage.
Whether we like it or not, income comes from only two sources: people at work or money at work. Upon retirement, you effectively become employed by the capital you’ve built up over your working life. Just as you wouldn’t want to work for an employer with cash flow problems and the constant threat of bankruptcy, you wouldn’t want your retirement capital to be insufficient to provide financial security and well-being for the rest of your life.
According to the 2023 Retirement Reality Report by 10X Investments, based on the Brand Atlas Survey, South Africa faces a significant challenge in retirement preparedness. The report reveals that only 6% of the population is on track to retire comfortably.
Today, people are living longer in retirement, and with rising medical expenses and expected lower interest rates, planning for retirement has become more complex. As a general guideline, if you begin saving for retirement at the age of 20, you would need to save 15% of your pre-tax salary annually over 40 years to accumulate 20 times your salary by the age of 60. However, if you delay savings until the age of 30, you would need to allocate 30% of your pre-tax salary each year to retire comfortably at 60. Starting even later, at age 40, would require an extraordinary 60% of your pre-tax salary to achieve the same retirement goals by 60.
The exact amount needed varies based on factors like income needs, inflation adjustments, retirement age, life expectancy, prevailing interest rates, and whether you’ll belong to a medical scheme post-retirement. Hence, working with a financial planner is crucial. At today’s money market interest rates (around 8.25%), R1 million in capital generates approximately R6 875 in monthly income, but bear in mind that this income is taxable as per your marginal tax rates, reducing what you have to live on.
Achieving Financial Security in Retirement
While your pension fund may be one of your most significant assets, it’s likely not sufficient on its own to meet all your retirement needs. Nevertheless, pension funds have been the backbone of retirement savings for South Africans, preventing many from facing destitution in old age.
So, why have pension funds been successful in accumulating long-term retirement capital? If we can learn from their success and apply these principles to our discretionary money, we may improve our chances of retiring financially stronger. The answer lies in three main reasons:
- Compulsory and Contractual Savings: Most occupational pension funds are mandatory as part of employment. This forces you to save regularly, ensuring you never miss a contribution while employed.
- Inflation-Linked Savings: Your pension contributions increase as your salary does, providing a form of “inflation-proofing” for your savings.
- Locked-In Savings: You can’t easily access your pension money to fund your lifestyle, allowing your savings to benefit from the “8th Wonder of the World”—the compounding effect of interest growth. This benefit continues until you leave your employer, die, or retire. Squandering your savings when leaving your job sets you back to square one, so preserving these benefits is crucial.
A Successful Savings Strategy
A successful savings strategy involves committing to saving contractually over a long period and increasing contributions to match inflation. It’s not about constantly chasing the best returns but adhering to the basic investing principles.
So, if these three factors have contributed to you having some retirement savings, what should you do to ensure a financially secure retirement?
You need a simple plan and should start saving for retirement as early as possible. For example, a straightforward and effective strategy is to set aside 15% of your salary each month from the start of your career and invest the contributions into market-linked investments like global tracker funds or equity unit trust funds. Reinvest the income and avoid touching it until retirement. The miracle of compound interest will do the rest.
Over a working lifetime of 30 or 40 years, this strategy can accumulate significant capital. Various investment vehicles like unit trusts, tax-free savings accounts, direct offshore platforms, endowment policies, and retirement structures can provide market access.
Why Do So Few Achieve Financial Freedom in Retirement?
Despite the simplicity of this strategy, only a select few achieve financial freedom in retirement. Several behavioural factors lead to the poor execution of this plan:
- Starting Too Late and Quitting Too Early: Many underestimate the power of compound interest.
- Lack of Discipline: Instant gratification often trumps long-term savings.
- Chasing Exotic Investments: Investors are lured by promises of extraordinary returns.
- Frequent Switching of Funds: Chasing past winners and current trends often leads to buying and selling at the wrong times.
- Relying on Gossip Rather Than Advisers: Decisions made on hearsay can be detrimental.
In general, far more attention is paid to fund choices, investment surveys, adviser commissions, charges, and fees than investor behaviour. Yet, investment returns are more dependent on behaviour than fund performance. History shows that most people need protection from their own poor savings habits when it comes to long-term retirement savings.
If you are a member of a pension or provident fund or have an RA and wish to boost your retirement savings, you can contribute up to R350,000 per year, which is fully tax-deductible from your gross income. It’s important to note that both you and your spouse can each benefit from these tax deductions individually, depending on your respective taxable income situations.
Similarly, tax-free savings accounts provide investors with the opportunity to contribute up to R36,000 each year, with the added advantage of tax-free investment returns. However, it’s essential to keep in mind the lifetime contribution limit of R500,000. If you consistently maximise your annual contributions, reaching this cap will take about 13.8 years.
Now is not the time to stop saving or procrastinate. Don’t fall into the trap of endlessly debating which product or fund is the absolute best for retirement while doing nothing about getting started. Often, the comparison isn’t about the best versus the good but about having something in place for retirement versus nothing.
The Value of a Financial Adviser:
People often underestimate the value an adviser brings by showing them why they need to save for retirement, how much they need, what it will cost, creating a budget, getting them started, and helping them stay committed through annual reviews. This guidance is often more valuable than the public expects miracles from advisers, especially for those who only start thinking about retirement after age 45.
Start Early, Keep It Simple, and Stay Disciplined
The key to successful retirement planning is to start early, develop a clear plan, and keep it straightforward. To generate a retirement income of 5% at age 60, you must accumulate a lump sum equal to 20 times that of your final salary. By withdrawing only 5% annually, this strategy should provide sufficient funds to last 30 years, accounting for inflation and ensuring a comfortable retirement.
Work with a good adviser and be disciplined about saving. If you struggle with saving regularly, consider a vehicle like an RA or discretionary investment and commit to regular contributions via a debit order, increasing with inflation.
Understand that saving for retirement isn’t a sprint but a marathon. Plan accordingly, stay committed, and get used to living on a budget that allows for necessary contributions. Let compound interest do its job, and you’ll be pleasantly surprised by what can be achieved over a working lifetime. Stick to your plan, and don’t get sidetracked by the noise around you.
