What re­tire­ment fund value re­ally means

CityPress - - Business -

We re­cently re­ceived an email from a reader who had taken early re­tire­ment and was con­cerned that the value of his fi­nal pen­sion ben­e­fit was sig­nif­i­cantly lower than the amount in­di­cated in his ben­e­fit state­ment six months ear­lier.

The pen­sion ben­e­fit, which was partly a lump sum pay­ment com­bined with a monthly in­come, was ac­tu­ally cor­rect; he had mis­un­der­stood the value of his lump sum once turned into an in­come for life.

In fact, be­cause he was part of the Govern­ment Em­ploy­ees’ Pen­sion Fund, his in­come was higher than he would have re­ceived through pur­chas­ing an an­nu­ity in the pri­vate sec­tor.

Un­der­stand­ing what your re­tire­ment fund re­ally means is un­doubt­edly one of the great­est chal­lenges when it comes to re­tire­ment plan­ning. When we look at our re­tire­ment fund­ing as a lump sum, it seems like such a lot of money – un­til we re­alise that it rep­re­sents our en­tire fu­ture in­come.

Take, for ex­am­ple, a 25-year-old who earns R20 000 from the first day of work. She works for the next 30 years un­til age 55 and only re­ceives an in­fla­tion-ad­justed salary in­crease. Over that pe­riod, she will re­ceive 360 pay cheques. Those fu­ture pay cheques, at the age of 25, in the cur­rent value, are equiv­a­lent to R7.2 mil­lion. Yet while R7.2 mil­lion sounds like a great deal of money, it only rep­re­sents an in­come of R20 000 un­til age 55.

The same ap­plies in re­tire­ment. Con­sid­er­ing that if you take early re­tire­ment at the age of 55 and you live un­til the age of 75 – which is rel­a­tively young nowa­days – you have to have enough money to pay for 240 pay cheques. If you needed an in­come of R20 000 per month, that would equate to about R4.8 mil­lion paid out over that time. So R4.8 mil­lion is not such a lot of money when you re­alise how long it has to last and, un­for­tu­nately, few peo­ple re­tire with any­where near this amount of money.

To pro­vide an illustration of the in­come that can be pur­chased at re­tire­ment, Alexan­der Forbes kindly pro­vided us with the fol­low­ing:

We con­sid­ered a male re­tir­ing at age 60 with a spouse who is four years younger than him. We as­sumed a joint life an­nu­ity, which means that his wife would con­tinue to re­ceive the in­come should he pass away first.

If he pur­chased an an­nu­ity in­come which in­creased each year by 5%, for every R1 mil­lion of pen­sion value, he would re­ceive an in­come of about R4 500 per month guar­an­teed for life, in­creas­ing by 5% a year. If in­fla­tion runs sig­nif­i­cantly above 5% a year, his pur­chas­ing power would be re­duced over time. That means, in or­der to have an in­come of R20 000 per month, he would have to have at least R4.5 mil­lion at re­tire­ment.

Al­ter­na­tively, he could pur­chase a liv­ing an­nu­ity and draw down 6% of the cap­i­tal each year (this is the max­i­mum rec­om­mended draw­down). A fund value of R1 mil­lion would pro­vide an in­come of R5 000 per month. At this rate, his in­come should in­crease in line with in­fla­tion. How­ever, by age 82, he would start to ex­pe­ri­ence a loss in pur­chas­ing power. This also means that if his wife out­lives him, at the age of 78 she would start to ex­pe­ri­ence a re­duc­tion in in­come. In or­der to have an in­come of R20 000 per month, he would have to have R4 mil­lion at re­tire­ment.

To un­der­stand ex­actly what your re­tire­ment fund means in terms of pro­vid­ing an in­come, you need to get some good ad­vice well ahead of re­tire­ment – es­pe­cially if you are con­sid­er­ing early re­tire­ment, as you have more years to fund.

Just look­ing at the fund value and be­liev­ing that it will be enough could mean in­suf­fi­cient re­tir­ment in­come.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.