In the second in our series of articles on the recent Old Mutual/ Personal Finance Retire Right seminars, we report on a presentation made by Bruce Cameron, the editor of Personal Finance, on the need to plan properly for retirement
Planning is the beginning and end of being able to retire right, Bruce Cameron, the editor of Personal Finance, says. "Without a plan and without constant revision of that plan, you will be in trouble."
Cameron says retirement can be broken down into three main stages: the build-up of retirement savings over your working life; the period shortly before you retire; and retirement itself.
Overlying all three stages is estate planning (which determines the fate of your estate when you die). Estate planning is imperative, particularly if you have dependants.
The issues you need to take into account vary at the different stages.
Stage One: The Build Up
When you start work it is almost impossible to predict how much you will need for retirement, how much you need to save, or when you will be able to retire. When you start working (or are in your twenties), retirement at age 60 is about 40 years away. But that is only 480 pay cheques away.
However, these early years are the most important of your entire career, because this is when you will accumulate money that will work for you, getting investment growth and then additional growth on what you have already earned.
If you have a retirement fund, you are off to a good start. If you do not, start a retirement annuity and invest a percentage of your income, preferably at least 10 percent.
By your early 30s, you should have an idea of when you want to retire, how much you need for retirement, and whether you are saving enough to meet your targets.
Stage Two: The Final Lap
The final lap is the last five to 10 years before retirement when you have to start preparing to make a number of decisions. The most important decision is whether you can afford retirement. You should be checking on a regular basis how much you need for retirement, how much you have saved, how much you need to save and when you will be able to retire.
Stage Three: In Retirement
In the final stage, you must check whether you will have enough money to last until you die. This means checking and adjusting you investment decisions and your spending habits on a regular basis.
A Financial Needs Analysis
Cameron says you will not find your plan in the stars or in a crystal ball. To get it right, you need a financial needs analysis.
For retirement planning a financial needs analysis can be used:
- In the build-up stages, to establish how much you need and to ensure you are on course;
- In the final lap, to plan your retirement structures; and
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- In retirement, to make the fine tuning to ensure you don't outlive your savings.
But a financial needs analysis is not a stand-alone procedure. It is part of an overall strategy.
Cameron says a financial needs analysis must not be implemented in isolation. It must encompass all your life goals. A needs analysis helps you:
- Identify how much you need for retirement and how your retirement plans fit in with your other financial goals, such as education of children or buying a home;
- Identify the needs of your dependants - should you lose your ability to provide for them;
- Identify how you should structure your medium- to long-term financial plans;
- Establish what you can afford and what you cannot; and
- Clarify your lifestyle goals.
A financial needs analysis is not a once-off event. The environment in which you live is constantly changing. Your personal circumstances change. Investment markets change. Investment products change as a result of many factors, such as tax and the easing of exchange controls.
Tax changes alone have had an enormous impact on the financial plans of individuals. Six years ago the government decided to start taxing the interest, net rental and foreign dividend income of retirement funds, meaning taxpayers had to save more to cover the loss of savings to tax. Last year, capital gains tax was introduced and this has affected the savings of individuals. Next year the government is expected to introduce major changes to retirement tax, which will affect your plans.
You should re-examine your financial plans:
- Every time your financial situation changes, when, for example, you lose your job or receive a significant boost to your wealth or income;
- When your life changes as a result of events such as marriage, birth of children or divorce;
- When there is a major change in the financial environment, such as the lifting of exchange controls or revised taxation; and
- On a regular basis, at least every second year and more often as you reach the final stages of retirement.
A financial needs analysis cannot be worked out casually on one sheet of paper. There are numerous sophisticated computer programs provided by financial services companies that can be used to help you do the job properly. There are also a number of important facts you need to take into account if you are to get the right structure to your plan. These include:
- Your age:
Age determines many things, including how much you will pay for life assurance and how much time you have to meet your financial goals. Age determines how far you are from retirement and how long you can expect to live in retirement. Average life expectancy is about 77 for low-risk men and 83 for women. Remember, these are averages. You could live for much longer, meaning you will need more money;
- Your earnings: Your earnings will determine whether you can afford your desired financial goals. It is not only about how much you earn, but also about how much you can save and how much you will spend in retirement;
- Your accumulated wealth:
Many people make the mistake of seeing high income as high wealth. A person who earns R4 000 a month and saves R1 000 a month will be far wealthier than someone who earns R30 000 a month and spends it all;
- Debts:
The money people owe is often excluded in calculations of wealth. Debt, even a mortgage bond, reduces your wealth and must be taken into account;
- Your dependants.
The number of dependants you have will have a significant impact on your plans. You should not regard children only as dependants. Increasingly, many people have to provide for aging parents;
- Your health:
Health has widespread repercussions on your financial plans - from the medical aid option you require, to limitations on your earning ability and even on how you should structure your retirement income;
- Lifestyle:
Your lifestyle both before and after retirement will, to a large extent, determine how much money you will have in the long term;
- Investment risk:
This is a critical factor and should be determined by your lifestyle requirements. If you cannot afford the level of investment risk to meet your lifestyle requirements, you may have to significantly alter your lifestyle; and
- Tax:
Your tax obligations will affect your plans, particularly as changes occur in the tax regime.
Balancing risk
An essential part of financial planning is about balancing risk. Some risks you can take yourself and some you must share. If you have a lot of accumulated wealth, then you can take more risks on your own.
For example, can you take the risk of having no savings when you die and jeopardising your family's standard of living?
The main tools for sharing risk are life assurance, disability assurance, and medical assurance.
Assurance provides you with a number of safeguards. These include:
- Protection against loss of income: You need to be sure that your dependants (and you, if you are disabled) can continue living at the same level as they could reasonably have expected when you were alive.
- Protection of savings plans: You may have savings plans for specific items that will be at risk if you die or become disabled. One of the best examples is the education of children.
- Protection against debt: People to whom you owe money have first claim on your assets when you die. For this reason you should make sure there is sufficient money in your estate to pay off all debts.
- Protection against taxation at death: Estate duty of 20 percent is applied to any amount above R1 million in net assets (your assets less your debts) in your estate. There is, however, no estate duty payable on any bequest by one spouse to another. You can get life assurance that will pay out on the death of the surviving partner to cover estate duty that will become payable on the inheritance.
- Protection of business interests: If you own a business, and particularly if it is a one-person business, it will probably need money to be a "going operation" after your death. It will cost money, whether you are in a partnership, with the partners all being essential to the success of the business, or whether your family needs to employ a manager.