Jacqui van Marcke, the business development manager at Momentum Investments, and Ben Fraser, the head of personal financial planning at Momentum Investments, discussed getting your retirement calculations on target at the recent Personal Finance/FNB Successful Retirement seminar.
Unless you are planning for it, you can banish all dreams of enjoying a wonderful retirement.
Jacqui van Marcke and Ben Fraser say that if you don't plan your retirement, you could be destined to:
- Never retire;
- Have your children, relatives or friends provide for you in your old age;
- Live on a smaller budget in your retirement than you are used to; or
- Have a miserable old age.
No one wants to find themselves in any of the situations mentioned above, but people who end up dependent or destitute either don't plan properly for retirement or make the wrong decisions at retirement.
South African reality
According to Van Marcke and Fraser, only six percent of South Africans are financially independent at retirement. The rest face a bleak old age:
- Sixteen percent depend on a state old-age pension, which is currently R740 a month;
- Forty-seven percent are dependent on family at their retirement; and
- Thirty-one percent are forced to continue working.
Be independent
If you would like to be financially independent at retirement, Van Marcke and Fraser say that it is imperative that you, together with your financial planner, design and activate your retirement plan as soon as possible.
Retirement planning is a lifelong process and consists of two phases:
- An accumulation phase, in which you plan for your retirement; and
- A post-retirement phase, during which you plan at retirement as well as during retirement.
It is no good accumulating everything you can up until retirement and then failing to use your money and assets wisely after you have retired, Van Marcke and Fraser say.
What you should expect from your financial planner
A financial planner should be a strategist and not just someone who sells financial products and who is after the highest commission possible to fund his or her own retirement, Van Marcke and Fraser say.
A planner should start by considering what will be your financial needs at retirement, and then develop a financial strategy for you, based on your needs. Only then should you and your planner select assets (shares, bonds, cash and property) and products to meet your goals.
Planning for retirement is not a once-off event. It is a process and it is important to review and adapt your retirement plan on a regular basis to ensure that you are on the right track towards a successful retirement, and that you remain on track.
Regular reviewing involves checking your retirement plan at least once a year or when a major event occurs in your life, such as the birth of a baby, the start of a new business or when you get a salary increase.
Quantifying your needs at retirement
The amount of money you need at retirement is determined by:
- Calculating the income and capital you need at and after retirement. For instance, your children may still be at university when you retire, in which case you will need to provide for them.
- Calculating what provision you have already made for retirement. Bear in mind that a pension or provident fund to which you are contributing is unlikely to be sufficient for your needs in retirement.
- Calculating your "retirement gap" - the shortfall between what you need and what you have made provision for, so far; and
- Implementing the necessary strategy to ensure that your "retirement gap" is adequately filled by the time you retire.
Insufficient retirement assets
Van Marcke and Fraser say people fail to save enough money for retirement for the following reasons:
- Procrastination
As the old saying goes, "never put off until tomorrow what you can do today". If you work out how many paydays you have left to retirement, you will realise that your retirement is not as far off as you think.
If you are 25 years old and you plan to retire at 65, you have 480 paydays. If you are 35, you have 360 paydays left. If you are 45, you have 240 paydays left, and if you are 55, you only have 120 paydays to retirement.
The key variables that determine how much money you will accumulate by the time you retire are: the time you have left to retirement, the contributions you make to your retirement investments and the growth rate you receive on your investments.
If you invest R100 a month for 40 years at an annual growth rate of 10 percent, you will accumulate R585 000. But if you have only 20 years to accumulate R585 000, also at a growth rate of 10 percent, you would have to invest R775 a month. This illustrates how time and compound growth affect your savings.
- Healthcare costs
Employers are no longer prepared to bear the risk or responsibility for funding their retired employees' healthcare costs, and are shifting that responsibility on to employees.
- Inflation
Inflation is referred to as the "cancer of money" because it eats at your money and you may not be aware of it until it is too late to take action.
There are two kinds of inflation of which you should be aware: general inflation and medical inflation.
General inflation is currently about six percent a year, while medical inflation is between nine and 10 percent a year. You have to take both types of inflation into account when planning for your retirement.
The Rule of 72 is used to calculate how many years it will take for the value of your money to halve. This is determined by dividing 72 by the rate of inflation. So, if general inflation is about six percent, it will take 12 years for the value of your money to halve.
To demonstrate the impact of inflation on your retirement planning, consider the following example:
Assume that you want to retire in 18 years' time with an income of R20 000 a month in today's value. The effect on inflation - assumed at six percent a year until retirement - is that instead of R240 000 a year (R20 000 x 12 months), you will need an annual income of R720 000 in your first year of retirement.
According to the Rule of 72, in 12 years' time, the equivalent of R240 000 will be R480 000 (72 divided by the assumed inflation rate of six percent equals 12). You have 18 years to retirement, so if you divide 18 by 12 (the number of years it takes for your money to halve because of inflation) you get 1.5. R480 000 x 1.5 = R720 000.
- Increasing life expectancy
Due to increasing life expectancy, your accumulated capital has to provide an income for a longer period.
The average life expectancy of men at the age of 65 is about 75 and for women, it is 79. However, these figures are general life expectancy ages. Your family history, health and lifestyle will determine the age to which you can expect to live.
Other effects of longevity is that your required income must keep up with inflation and your medical expenses may increase as you get older.
Bear in mind that women tend to live longer than men. It is therefore important for a married woman to take this into account when doing her individual retirement plan, or for spouses to take into account when planning jointly for retirement.
- Using money earmarked for retirement for other purposes
Often, when people resign, they are advised to pay off their debts using a withdrawal benefit from a pension or provident fund. But, Van Marcke and Fraser say that if you are prone to accumulating debt, you may find yourself in the same debt position as before. Even worse, you would also have lost your retirement capital.
Taxation
Contributions to a retirement annuity or a pension fund are tax- deductible up to certain limits. The growth on retirement fund contributions is taxed favourably and is not subject to capital gains tax.
There are also certain tax benefits at retirement in terms of which you get a portion of your retirement benefit free of tax.
You should make the most of these tax breaks in planning for your retirement, Van Marcke and Fraser say.
Investing your money
The key strategies when investing for retirement are to diversify across investment types and to invest according to your time horizon, Van Marcke and Fraser say.
The longer you have to go until retirement, the greater risk you may assume with your investments, because equities tend to be less volatile over a longer period.
However, as you approach retirement, you need to become more conservative with your investments in order to consolidate and protect the capital you have accumulated.
It is also important to regularly review your financial action plan.