If you want to retire right, you need to get your planning right, Di Turpin, chairwoman of the Association of Unit Trusts, and Bruce Cameron, editor of Personal Finance, told the Personal Finance/Old Mutual Retire Right seminars in a joint presentation. This is an edited version of their presentation on the fundamentals of retirement.
To ensure you can retire right you have to make plans in three stages, adapting your plans to meet the stages. Each stage is as important as the other. The stages are:
* The build-up: This stage should begin from the day you first start earning an income;
* The final stretch: This is the five years before retirement in which you should be finalising your retirement plans; and
* Your retirement years: This stage is not an end but a start to a new phase.
To plan properly you need to establish your goals, needs and wants in life, namely the issues which cost money, such as educating children, buying a home and your chosen retirement locale.
There is no magic solution or single plan that everyone can adopt to ensure a financially secure retirement. Everyone's financial circumstances are different. These include;
* Age:
This is one of the more important factors. Age at retirement is the key factor in determining how much money you will need after retirement. On average low risk men can expect to live to be 77 and women 83. The problem is that very few people can predict how long they will live;
* Earnings:
This is not only about how much you earn in the build-up to retirement but also about how much you will spend in retirement. You have to consider what happens if you are not able to earn for as long as you wish for reasons of ill-health or disability;
* Dependants:
People who are dependant on you can be a changing scenario. For example, children may depend on you for longer than you anticipate, upsetting your retirement plans. You may also find that your parents become your dependants for a number of reasons including their poor retirement planning, inflation undermining their retirement benefits or high healthcare costs;
* Health:
You can never be sure that you will be as fit tomorrow as you are today;
* Lifestyle:
A spendthrift will not retire right as easily as someone who is thrifty;
* Risk:
The risk you are prepared to take in investing your retirement savings; and
* Taxation:
This plays a significant part in any retirement plan.
The question is: How do you plan correctly for and in retirement to ensure you do not outlive your capital when there are so many variables?
Financial needs analysis
There is a lifeline - a financial needs analysis.A financial needs analysis does a number of things for you:
* It helps identify how much you need for retirement and to meet other goals;
* It identifies your retirement targets;
* It can help you structure your medium to long term plans;
* It tells you what you can afford and what you cannot;
* It clarifies your lifestyle goals, often giving you a wake up call; and
* It helps ensure you get appropriate advice.
Be aware that a financial needs analysis is not a once-off event. Every time something changes in your life you need to analyse your finances again, for example when you start work, when you get married, have children, become a single parent, have a death in the family, change jobs, or have a big increase/decrease in income.
Five years ago a financial needs analysis was not something you came across very often, but nowadays every good financial adviser has access to a financial needs analysis computer program.
A financial needs analysis is like a health check-up. You may not think anything is wrong but there could be. If everything is fine then you have peace of mind. But as with a health check-up you must be prepared to pay for good advice.
You can also find standard financial needs analyses on the websites of most financial institutions.
Making plans
In making your plans based on your financial needs analysis you must take a number of steps. These include:
* Prioritise:
You will probably find that you cannot achieve all your targets. You need to come to terms with the fact that you can't do it all and that life is about priorities. Weigh up your needs and what you should be doing. Then look at what you can afford and make a commitment that at the very least you will save a certain amount.
* Be conservative:
In making your plans you must be conservative. Don't presume that money will fall from the sky, that you will inherit or that you will win at the casino. Presume you won't. Plan for stock markets not to do well, that you won't get that big increase you think you deserve and invest sensibly even if you think gold has always been the place to be. Play with your spending cash, not your retirement money.
* Don't procrastinate:
Don't put off starting to invest because you are not sure where to begin, or you may have time over Christmas to look at your finances, or to chat to your brother-in-law who is a big shot in the financial world. Nobody knows your needs better than you and you are kidding yourself if you think you'll do anything bigger or better at some other point in time.
The first time it is a pain, but it gets easier each time you review your plans. The longer you leave building a retirement nest egg the more difficult it becomes, as you miss out on your biggest friend, compound interest (see graph).
* Take it one step at a time:
Each little step makes it easier to reach your end goal, even if you are not quite sure what it is and when you will get there.
* Review:
One of the critical steps in the planning process is reviewing what you did each year and where it leaves you now. Your circumstances change constantly and they will definitely affect your financial planning.
Once you have completed a financial needs analysis you need to match your needs and the affordability of your plans with the wide selection of available products. This applies in the build-up, in the final lap and in retirement.
You will probably use the same product vehicles in the build-up and in the final lap prior to retirement, making adjustments to lock in past growth and reduce your levels of risk, while in retirement you will need to look at new products.
Retirement products fall into fairly simple broad categories.
Pre-retirement products
In the build-up to retirement there are three broad categories:
* Employer-sponsored vehicles:
If you are employed you will probably be offered a pension fund or a provident fund.
Defined contribution funds, where the amount paid in is defined but not the pension, allow you to choose where your money is invested and how you may access it, whereas defined benefit funds are generally more closely administered by the trustees and offer set benefits on retirement depending on your age and status in the company;
* Voluntary vehicles:
These are for any money you decide to save for your retirement. They offer some tax advantages for investing (as does your pension fund money). The money is only available, strictly speaking, when you reach retirement age.
Retirement annuities (RAs) are essentially investments in retirement funds open to anyone. There are many different kinds of RAs, ranging from ones that invest in life assurance funds to ones that invest in unit trusts; and
* Vehicles for retrenchment, early retirement or resignation:
If you are in an employer-sponsored fund and leave the fund, you can transfer your savings to a preservation fund or a retirement annuity.
Retirement products
* Employer-sponsored funds:
With the exception of provident funds, where you can withdraw all your cash and invest it wherever you wish, two-thirds of pension funds must be used to provide a pension. With a defined benefit fund, the pension will be provided in terms of the rules of the fund. With a defined contribution fund, the fund trustees will have made a call about how much flexibility you have in selecting a pension product.
* Voluntary vehicles:
A retirement annuity is treated in the same way as a pension fund. Increasingly, however, you are being offered a wider range of pension choices. The main two choices are a living annuity, where you take the investment risks, and a traditional annuity, where a life assurance company takes the risk in paying you a pension until you die. Preservation fund money can be converted into the same choices. If you are in a preservation provident fund then you can take all the money as a lump sum.
HEALTH WARNINGS
The retirement gap
If you are a member of an employer-sponsored fund, do not rely on it alone to provide you with a financially secure retirement. After being a member for 30 years, your income on the day you retire is likely to drop by 40 percent.
Preserve your retirement savings
The biggest danger to your retirement capital occurs when you change funds, particularly when you change jobs and you use the money for something else. You have four choices:
* If the fund rules allow it, leave the money where it is and defer the withdrawal until retirement. You will save up to seven percent in re-investment costs;
* Again if the rules allow, transfer to the fund of the new employer. There are unlikely to be reinvestment costs;
* Reinvest in a retirement annuity; or
* Reinvest in a preservation fund.
Investment risk
We tend to think of risk in terms of our own risk appetite. Compared to many other nations in the world, we are likely, on average, to have a higher risk appetite. Too many investors invest in sector funds or small-cap stocks without fully understanding the fundamentals behind the behaviour in those categories or stocks. When looking at risk you should be more pragmatic, particularly when it comes to your precious retirement money. You should not look at your own personal appetite for risk. Rather you should look at the time you have left to retirement, as well as your ability to take the knock should things go wrong. Design your retirement portfolio around a conservative core that offers you protection, and then add elements of higher risk to your investment.
Health risk
Healthcare is an increasingly important factor in retirement planning. Even if you don't think you will ever need nursing care, remember that medical costs are constantly rising. With the many social problems facing Africa and therefore South Africa, we can almost guarantee that they will keep on rising.
Consider yourself first
Too many people consider what they want to leave to heirs rather than what they need for a healthy financial retirement. Your money will be worth less by the time your heirs get it and it may have to be split a number of ways. Many people choose the wrong retirement vehicles because they are considering their heirs rather than themselves.