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27 November 2012
RETIREMENT is a pressing concern – how do you ensure you will be comfortably off once you hang up your power suit and dress-for-success outfits?
The recipe for accumulating sufficient retirement savings is based on a few key ingredients. Get the combination right and you will have sufficient retirement savings to enjoy a prosperous and financially independent retirement.
But be warned: the absence of just one ingredient can result in one’s golden years being a time of great uncertainty, and financial dependence on the state or loved ones.
Here is a breakdown of each of the ingredients for a successful retirement strategy.
Net contribution rate
A sustainable contribution rate is the foundation of a good retirement saving strategy. This is also the component you have the most control over.
Many people believe that the monthly contribution to their retirement fund or annuity goes directly to savings. In most cases, costs for administration and any risk benefits may be deducted from this contribution.
In this article, we will assume that all contributions are quoted after the deduction of fees and risk costs.
Retirement fund members are advised to make sure they understand what costs are being deducted from their contributions, so that they have the most accurate picture of what they are putting away for retirement.
There is no doubt that a net contribution of 6% is too low.
For a person saving from age 18 to retirement at age 60, such a contribution could realistically provide a pension in the order of 30% of the pensionable salary he or she enjoyed before retirement.
Put another way, if you were earning R10 000 per month before retirement, your income on the day of retirement at age 60 would plunge to about R3 000.
This could have a severe impact on your standard of living.
But if you contribute at a rate of 12.5%, 20% and 27.5% respectively, could expect a projected pension in the order of 65%, 100% and 150% of pre-retirement income at age 60.
Had you started saving for retirement just 10 years later, the expected pension at age 60 would have dropped to around 45%, 71% and 100% of pensionable salary before retirement, respectively.
Length of saving period
The above reduction speaks to two very important aspects of a retirement saving strategy.
It is crucial to start saving for retirement as early as possible.
Secondly, once you have started saving for retirement it is essential not to withdraw your accumulated retirement savings before retirement.
Be warned: the act of withdrawing and spending retirement savings before normal retirement age is the single biggest culprit for so many South Africans retiring in poverty.
For someone who starts to make a 6% contribution to their retirement fund at age 28 and expects to retire at age 60, the expected pension at retirement is in the order of 20% of pensionable earnings in the year prior to retirement.
If at all possible, extending retirement age to 65 at the same contribution rate will boost the projected pension by 10%.
In the calculations above, an investment return of 5% in excess of inflation has been assumed, which would be representative of a portfolio with a moderate equity exposure.
Long-term investment return can have a significant impact on accrued retirement capital.
For example, someone investing 6% of pensionable income from age 18 to retirement at age 60 with an investment return of 3% above inflation could expect a pension in the order of 15% of pre-retirement income.
If this investment return was increased to 7% above inflation the projected pension would double, all other things being equal.
If you are looking for ways to improve your retirement savings and prospects, it is a wise move to raise contributions to the maximum amount you can afford.
Retirement fund contributions are tax deductible and the returns on those contributions do not incur tax. So, retirement fund saving is very attractive from a tax perspective.
The option of withdrawing retirement fund capital should be completely excluded. You can make use of tax-efficient preservation funds to protect accumulated capital for when it is needed most – at retirement.
Contributions should be invested in an appropriate style.
Younger investors should focus on investments that provide inflation-beating capital growth. As you approach retirement, your focus should shift to protecting accumulated capital for the purchase of a pension.
And if you have any doubt about your path to a financially independent retirement, it is important to seek advice from an accredited financial adviser as soon as possible.