Retirement 101

Retirement 101

Creating your long-term saving goals (this is retirement for many people) is not something that you can simply decide on the spot - and often, these goals may change over time. Before you even get into some of the technicalities of long-term saving strategies, as we will cover in this blog, you need to know why you’re saving - and what you’re saving for. When you know the why, the how is much easier.

This should become an ongoing conversation with your financial advisor - one blog simply cannot cover it all - but hopefully it will help you on your journey!

Given the advances already made in the fields of technology and medicine, we are living longer than previous generations, which means that a balanced and robust portfolio will make provision for a long and happy retirement after you hang up your work boots.

Delaying saving for retirement is not uncommon, as other life costs can easily seem more important when you are young. Even those who are forced to save — as a result of a compulsory deductions at work — still might not have enough when it comes to retirement age.

It’s not only how much money we save that counts, but also when we start saving. Your retirement should be a time when you finally get to reap the rewards of decades of hard work. However, if you wish to enjoy these golden years in comfort, it’s best to start saving when you're young, as the earlier you start, the less you need to put away each month.

Many people only start saving at the age of 28, rather than when they first start work. And there are even more who wait until their thirties, or later still. The problem is that if you start later on in life, you’re not just faced with trying to catch up on the amount that you could have been putting aside before, but you also need to make up for the compounded returns that you've missed out on. The earlier you start saving, the more you can benefit from the market contributing to your retirement through the power of compound interest.

For example, if you start saving ZAR5,000 a month at 25 years old, at an
annual average of 6% return, you’ll have more than ZAR7-million by the time you hit 60.

However, if you start saving the same amount a decade later, you will only have ZAR3.46 million by the age of 60. You’ll, therefore, need to increase your savings to ZAR10,000 a month to reach ZAR6.9 million in your 25-year investment horizon.

How much will you need

The first step towards saving for your retirement is to figure out how much you will likely need. Most retirement experts in South Africa advise that you’ll probably need to replace about 75% of your current income to retire comfortably, assuming you don’t have a home loan or any other large debt by that age. Peter Doyle, the former president of the Actuarial Society of South Africa, explains that “12 times your annual salary is likely to buy you a financially comfortable retirement.”

However, in recent experience we are finding that those wanting to retire need about 90% replacement ratio, especially as medical expenses are likely to rise as you get older.

To achieve a comfortable retirement, it is widely recommended to save at least 15% of your gross income over a 40-year career if you start saving at the age of 25. However, a late start or early retirement would obviously require a much higher savings rate.

How to save

When it comes to saving for retirement, you need inflation-beating investments and as much time as possible to benefit from the compound interest.

There are various retirement plans that you can choose from. The most tax efficient way of saving in South Africa is arguably to invest the maximum percentage of your salary possible in your company’s pension scheme and/or a retirement annuity (RA).

The good news is that contributions to a retirement annuity, which you can invest in through a financial services provider; and/or pension or provident funds, which are provided by employers, are tax deductible up to a certain amount (you can contribute up to 27.5% of your gross remuneration — up to a maximum of ZAR350,000 per year — to a pension fund or RA). And, as you can save pre-tax with these vehicles, you can benefit from the compounded growth on a larger amount.

A major benefit of an RA is that all growth is completely tax-free, but it is important to review all the costs, as life-linked retirement annuities can be expensive. If you do wish to invest in an RA, it’s advisable to select one that has no penalties or obligation for monthly contributions. The best ones don’t have any upfront fees and operate on a pay-as-you-go basis.

More flexible retirement products are usually unit trust-based, as these allow you to decide when and how much you want to contribute. Generally speaking, a balanced unit trust offers a good savings option for retirement, as it should provide adequate equity exposure for long-term growth, as well as more stable asset classes that can mitigate the investment risk.

You can also supplement your savings by investing in a tax free savings account (TFSA), an investment property, or trading in shares. A tax-free investment could be a suitable additional investment, as it still offers tax benefits without some of the restrictions that can come with a retirement annuity. However, it does have its own restrictions — a TFSA currently only allows for tax-free savings of ZAR33,000 a year, and a lifetime limit of ZAR500,000.

How to play catch-up

It’s worth aiming to save at least ZAR15 of every pre-tax ZAR100 if you have a 40-year timeline. However, if you want to retire before the age of 65, or put off saving until your thirties or later, then you will need to increase that saving rate. If you start saving at age 30, you will likely need to save 20% of your gross income, while starting at 40 years old will mean you will need to save 42%.

If you’ve left it late or realise you need more savings to retire comfortably, the easiest way to solve this problem is to save more (saving an extra ZAR4,000 a month on a ZAR40,000 salary will make a big difference). If you are willing to cut back on expenses, find a way to generate extra income, inject part of your annual increase or bonus, or pay off your debts as quickly as possible, then invest the freed up money. Essentially if you clean up your budget, and get into the habit of saving regularly, you can work towards a healthier retirement fund.

You may also need to be more aggressive when it comes to investing. A widely accepted rule of thumb is to subtract your current age from 100 and invest that percentage of your portfolio in equities, or many people now follow the ‘110 rule’ as we are living longer. So, if you’re 30 years old, you’d invest 80%, and you’d decrease this to 70% at age 40 to also decrease the risk in your portfolio as you get older. However, if you don’t have enough saved for whatever reason, you may well wish to increase the equity portion of your portfolio. Don’t hesitate to arrange a meeting to discuss this so you can make an informed decision and not take unnecessary risk.

Another thing to bear in mind is to preserve your benefits rather than take the cash if you are offered withdrawal benefits or change jobs. Furthermore, although you can also access your savings in preservation funds and retirement annuities at age 55, it’s best to again keep your money invested. Don’t be tempted to use your money for anything that is not essential, as you should be adding to your savings at this stage, rather than eroding them.

Saving for retirement can seem a complex task, but it doesn’t have to be if you do a bit of research and arrange a meeting to discuss the different retirement plan options available. Building a diversified retirement portfolio will depend on your assets, your risk profile, your age and your financial goals, but you’re on the right track once you have picked a strategy that you trust, and have established a suitable retirement portfolio. This should then be reviewed at least once a year — even quarterly — so you can track whether you are saving enough and make adjustments if need be. This can be done at the same time as your tax planning so you can ensure you are taking full advantage of all the tax breaks each year.

(blog ideas were added to from fin24.com)

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