The Money Guide: Retirement (part 1)
How much do you need to save for retirement?
Here's how to do the all-important calculations
How much do you need to save for retirement? This question is one of the most important ones you need to answer to take charge of your financial future and ensure you retire with enough savings to provide an adequate pension.
You should not assume that because you contribute to an employer-sponsored fund, or because a financial adviser has signed you up to contribute to a retirement annuity (RA), that you are on track for a comfortable retirement.
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You should always check for yourself or ask your adviser to show you what you will receive as a monthly pension in retirement, and, if you will be living off investments in a living annuity, for how long these are likely to provide that pension.
Working out how much you need to save may seem like one of the hardest calculations, but there are ways to tackle it and some calculators to help you do the maths.
You need to remember that the answer will be a bit of a moving target as your life changes, particularly as your income grows, or you marry or take on other dependants, so it is important to revisit your calculation from time to time.
Your savings in a company-sponsored fund or an RA
If you have joined your company retirement fund, your employer will determine how much you will contribute to your fund and how much it will contribute, or it may give you a choice of how much to contribute within certain limits.
The trustees of your fund are likely to recommend how much you should contribute to achieve sufficient savings for you to buy a pension at retirement that is equal to between 60% and 75% of your final salary.
The calculation will be based on you contributing to your retirement savings throughout a working life of 40 years, from age 25 to 65.
And it will assume you do not cash in your retirement savings.
Typically, the percentage of your salary that you and your employer should contribute to your fund will be between 12% and 15% of your gross salary.
You need to remember that this calculation is based on a number of assumptions, including about how long you will save for and the return you will earn. Your actual circumstances may be different.
The following factors may result in you ending up at retirement with a lower percentage of your salary as a pension than your fund targets:
- if you start saving late;
- if you have not enjoyed reasonable investment returns in line with long-term averages;
- if you are paying high fees on your investments;
- if you have withdrawn your retirement savings on changing jobs; or
- if you receive a large increase late in your working life, resulting in you wanting a pension equal to a percentage of a much higher salary than the one on which most of your contributions have been based.
If, for example, to achieve savings able to provide a guaranteed, inflation-linked annuity that replaces income equal to 75% of the salary you are earning when you retire, you need to contribute 15% of your salary over a 40-year period and earn a return of 3% above inflation, this is how starting at a higher age will affect the percentage of your salary that you need to save:
- 15% of your salary if you start at age 25;
- 19% of your salary if you start at age 30;
- 24% of your salary if you start at age 35; and
- 33% of your salary if you start at age 40. *
This assumes you’re a man, and that your income grows at a rate of 7% per year, of which 6% is inflationary growth. If you’re a woman, you will need to save even more because you’re likely to live longer.
If you’re self-employed, your financial adviser may have encouraged you to contribute to an RA, but a good adviser will have calculated exactly what you need to contribute to achieve a reasonable income in retirement.
When you start calculating what you need, you first need to set your retirement goals.
How much income will you need in retirement? When you think about this question, consider the following:
- Will you have paid off all your debts, such as your home loan?
- Will you still be supporting dependants such as your children or other relatives who rely on you for their living expenses?
- Where will you live? Will you downscale your home, making the cost of living cheaper?
- What will you save on transport costs or the cost of owning a car or more than one car when you are no longer working?
Answering these questions will help you determine what percentage of your current salary you will need to meet your expenses in retirement.
Then you need to consider if you will need any capital lump sums during your retirement for the following:
- Increased holiday and travel expenses, especially in the early years of your retirement.
- Major expenses in retirement such as the replacement of a vehicle or home maintenance.
- Major medical events that may incur expenses not covered by state health facilities or your medical scheme, or events that may incur non-medical expenses, such as adapting your home.
A rough guide
For a rough guide or rule of thumb to check if you’re on track to achieve your retirement goal, financial services companies suggest you should have between 15 and 17 times your final annual salary (before tax) in the year you retire to provide a pension equal to 75% of the salary.
The different multiples are a result of different underlying assumptions, particularly about the cost of providing a pension in retirement and whether you use a guaranteed annuity bought from a life assurer or an investment-linked living annuity bought from an investment platform.
Life assurers say that for every R1-million you’ve saved at retirement, you can currently get a guaranteed pension for life of R6,000 a month if you’re a man and R5,400 if you’re woman (excluding a surviving spouse’s pension). This pension would increase each year with inflation.
You can check whether you’re on track to have 15 times your final salary at retirement by ensuring you have a certain multiple of your salary after every five years you have worked.
Years worked Multiple of current salary you should have saved **
If you are not on track, you have only three options:
- save more;
- retire later; or
- live on less than 75% of your final salary when you retire.
The statement you receive from your fund may even inform you what percentage of your current salary your savings will provide as a pension, assuming you continue to save at the current level until your retirement age and earn the average returns the fund assumes you will enjoy.
Save more and save tax
Saving more in a retirement fund can reduce the tax you pay because your contributions are tax deductible as long as you do not exceed certain limits or maximum contributions.
These maximums are the lower of:
- 27.5% of your remuneration (what an employer pays) or your taxable income (which may be higher if, for example, you earn income from a business or from renting property); or
- R350,000 a year.
If you want to save more and belong to an employer-sponsored pension or provident fund or an umbrella fund, which is home to members from multiple employers, find out if the rules of the fund allow you to voluntarily increase your contributions, as these funds typically offer the most cost-effective way to save. If you are not able to do so, you can make use of an RA fund.
* 10X Investments 2017; ** Sanlam Benchmark Survey 2017
This guide was written by the Money editorial team at Tiso Blackstar, sponsored by 10X Investments.
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