You will need more money to retire on than your grandparents and parents did, not only because of inflation but because you are likely to live longer. But South Africans today are saving less than previous generations, a primary reason being that when they change jobs they often withdraw and spend their retirement savings, in many cases using the money to pay off debts. At this month's acsis/Personal Finance Financial Planning Club presentation, Andrew Davison, the head of institutional asset consulting at acsis, spoke about the importance of preserving your retirement savings.
It is likely that you will live a lot longer than your grandparents, and so your retirement savings will |have to last a lot longer too, Andrew Davison of acsis says.
Your grandparents may have retired at the age of 60, expecting to spend about 10 to 15 years in retirement, he says. But advances in medicine and healthier lifestyles mean that people who retire at 60 today can expect to live about 20 to 25 years in retirement.
Despite these facts, Davison says studies show that people are saving less for their retirement. According to the July 2010 Old Mutual Savings Monitor, South Africans are saving less in order to service their mid- to long-term debt, which includes credit card debt, store card debt and personal loans.
In South Africa, retirement funds have moved from being predominantly defined benefit funds to being predominantly defined contribution funds, Davison says.
A defined benefit fund provides you with a pension that is calculated by taking account of your salary at retirement and how long you belonged to the fund. A defined contribution fund, on the other hand, provides you with an undefined final amount, with which you must buy a pension. Only the contributions that you and your employer make to the fund are defined, Davison says.
The risk that you will not have saved enough for your retirement lies with you, and this is why you have to be proactive about saving for retirement, he says.
"You have to take responsibility for your retirement fund, because you are carrying the can," he says.
The biggest killer of retirement savings is not preserving your savings. "Unfortunately, people tend to access their retirement savings when they change jobs, instead of preserving those savings by transferring them to a different retirement fund or a preservation fund," Davison says.
If you leave a retirement fund because you change jobs or are retrenched, you have the option to transfer your savings into a preservation fund. In this way, you will |preserve both your savings and |the tax benefits that are due to you.
Davison says that if you choose to use a preservation fund, you must transfer your savings from a pension fund to a pension preservation fund or from a provident fund to a provident preservation fund. You may not make further contributions to a preservation fund.
Although retirement may seem a long way off it is important to appreciate the challenge of saving enough. Consider Jack, aged 25, who starts working and earns a monthly salary of R10 000. Jack's salary increases by seven percent a year over his working lifetime until he retires at age 65. In order to have roughly the same standard of living in retirement, Jack will need a pension of about 70 percent of his final salary, and the pension will need to increase annually in line with inflation. In this scenario, Jack will need to have saved just more than R13 million. If he diligently saves 11 percent of each salary payment, he will need an investment return of about 3.5 percent above inflation each year on average. This means that there is no room to be too conservative in his investment strategy. If Jack saves a lower percentage, skips contributions for any reason or fails to preserve his savings, the required return above inflation is even higher.
Davison says your final objective should be to retire with a pension of 70 to 75 percent of your final salary. It does not have to be 100 percent of your final salary because, when you retire, your expenses - for example, saving for retirement, tax, children's education and transport - will decrease, enabling you to maintain your pre-retirement lifestyle.
He says you should not underestimate the power of compound interest and the benefits of saving for your retirement from the first day you start to earn a salary.
"The money you put away in the first 10 years of saving will have earned huge amounts of growth by the time you retire - and this is where the bulk of your retirement savings come from," he says.
Simple formula
Davison says the formula for saving for retirement is simple: contributions plus investment growth. The only other factor to take into account is time: how early you start to save and how long you save for. There are many different ways for this formula to work.
For example, say you have a working life of 40 years, you save 10 percent of your salary from the time you start to earn an income and you invest your savings so that they grow at five percent above inflation each year. If you earn R10 000 a month at the age of 25 and your salary grows at six percent a year, you will earn a cumulative amount of R18.57 million over 40 years and you will have contributed R1.857 million to your retirement savings during that time, he says.
If you start your retirement with a pension of 70 percent of your final salary, and your pension increases at the same rate as inflation, the cumulative amount of your pension required from age 65 to age 80 will be about R20.1 million.
Given that you have contributed R1.857 million, this means that you will require total investment growth of R18.25 million. So the investment growth you require is almost as much as the cumulative salary you earned during your working life.
"This means that even if by some miracle you did not use a cent of your salary in all your working years and, instead of investing it, you put all that money under your mattress, you still would not have enough money for your retirement," Davison says.
Ultimately, your retirement savings should be equivalent to about eight times your final annual salary when you retire.
If you withdraw your retirement savings at any point during your working life, you will need to save a higher percentage of your salary from that point on, because you will have a shorter period in which to earn growth on your contributions.
For example, say you start working at the age of 25 and plan to retire at 65, you save 10 percent of your salary each month, your investment grows at 4.2 percent above inflation each year and your goal is to receive a pension of 70 percent of your final salary, increasing with inflation each year. Davison says that at the age of 35 you will have saved the equivalent of 1.1 times your annual salary. If you change jobs at this age and access your retirement savings and then start saving from scratch, you will have to save 16 percent of your salary each month to meet your goal of receiving a pension of 70 percent of your final salary.
At the age of 45, you will have saved the equivalent of 2.7 times your annual salary. If you access your retirement savings at this age and then start saving from scratch, you will have to save 28.6 percent of your salary each month to meet your goal of receiving a pension of 70 percent of your final salary.
"This is why the preservation of your retirement savings is of paramount importance. It is simply not that easy to play catch-up at a later date, and you are likely to end up with a shortfall in your retirement years," he says.
TAX BENEFITS ON RETIREMENT SAVINGS
- Pension funds.
Your contributions up to 7.5 percent of your pensionable income (your basic pay without allowances) are tax-deductible. Your employer's contributions are tax-deductible up to 20 percent of your income. All the returns are tax-free.
- Provident funds.
Your contributions are made with after-tax money, so they are not tax-deductible, but the investment growth on the total contributions is tax-free. Your employer's contributions are tax-deductible up to 20 percent of your income.
- Retirement annuities.
Your contributions of up to 15 percent of your annual non-retirement-funding income (that is, income not used to fund pension or provident fund contributions) may be claimed as a tax deduction.
WHAT YOU SHOULD BE DOING
It is important that you take an interest in how your retirement fund is being managed, Davison says.
"Don't just assume your fund trustees will look after you. The fund is your vehicle to retiring comfortably, but you still have to get in and drive it," he says.
Davison recommends the following:
- "The fund rules and financial statements have a story to tell you if you take the time to read them. Take the time to understand the investment options available to you instead of simply allowing the fund trustees to choose the default option on your behalf. Often, the default option represents a middle-of-the-road scenario, which may not be the best choice for you," he says.
- If you have the option to choose how much you contribute to the fund, choose one for yourself and do not assume that the default option is the best one.
- Use financial calculators |and other investment tools to determine whether or not your retirement savings are on track. This will help you see where you stand and enable you to adjust your savings strategy before it is too late.
- Question your trustees. The Financial Services Board (FSB) has published recommended guidelines on the way a fund should be managed. Check that your trustees are following these guidelines. You can find the guidelines - in PF Circular 130 - on the FSB's website ( www.fsb.co.za). From the home page, click on "Retirement funds", then on "Retirement funds" and then on "Active PF circulars".