What you need to get right in saving for retirement
Starting to save early is the best plan, but there are many variables
● Wising up early in your working life to a few hard truths about providing an income in retirement will help ensure you are not one of the 95% of South Africans who will retire with a standard of living well below that to which they are accustomed.
In order to target a sustainable pension that is equal to a certain percentage of your final salary — typically between 60% and 75% of that income — you need to save a certain percentage of your salary for a certain period and get a certain level of above-inflation after-costs returns.
This will give you a level of savings that you can use to buy a guaranteed pension that pays for life, or invest to generate an income. If you invest to provide an income, the level of income you draw in retirement and the returns you earn — and the order in which you earn them — are also key factors that will determine how long your pension will last.
At a recent South African Independent Financial Advisers Association seminar, representatives of two financial institutions presented the challenges you face when trying to get these factors to work together in a way that ensures you can retire comfortably.
Less time to save
Our working lives are getting shorter and retirement years are getting longer. This means the number of years you have available to save for retirement has reduced dramatically. Many people are entering the workforce later following tertiary education and choosing to, or being forced to, retire earlier. However, as a result of improved health and medical advances, people are living longer in retirement.
Patrick Sheehy, the head of product management at Glacier in the Sanlam group, says that in 1960 retirees lived on average seven years in retirement. That number is now approaching 25 years, he says.
Hamilton van Breda, head of retail sales at Prudential, says people in the Silent Generation and baby boomers (born before 1966) used to work for up to 47 years, from age 18 to age 65. People from Generation X (born between 1966 and 1976) and Generation Y (born between 1977 and 1994), are working around 38 years, from age 22 to age 60.
These shorter working lives and longer retirements means that the number of years for which you save relative to the number of years your savings need to support you in retirement has reduced by 41% from a ratio of 2.47 for people born before 1966 to 1.41 for people born after that year, Van Breda says.
Younger generations facing this challenge should check the retirement income that their savings are on track to generate before it becomes difficult to correct.
When it comes to planning how much you need to save, women and couples have an added challenge. Statistics show that South African women outlive men by seven years on average, Van Breda says.
Couples thus need to plan for a retirement income that lasts at least seven years longer than the life expectancy of the man. Single women and women couples need to consider retiring later or saving more to provide for a retirement that could span 30 years.
Juggling the relevant factors can make a huge difference to your retirement income. The numbers matter if a typical retirement savings plan is to save 15% of your income for 30 years and to earn a real (after-inflation) return of 4% a year, you are likely to achieve a pension that is equivalent to 60% of your pre-retirement income. This income would, depending on market conditions, probably last for about 21 years, Van Breda says.
He says changing the relevant factors can, however, make a huge difference:
Decreasing the amount you draw as a pension in retirement — reducing your income to 43% of what you were earning before retirement — could increase the number of years your income lasts to 39 years.
Increasing the amount you save each year — increasing your retirement fund contributions (yours and your employer’s) from 15% to 22.5% of your income could give you a pension equal to 90% of your pre-retirement income.
Increasing your exposure to growth assets such as equities and listed property — decreasing your after-inflation return to 1% by investing conservatively in cash or a fixed income fund while still drawing an income of 60% of what you earned before retirement — will reduce the number of years your income will provide a sustainable income to 15.8 years. Increasing your real return to 6%, however, will increase the number of years you can provide a sustainable income to more than 30.
If you are still young enough to start saving early, this is the best way to boost your retirement savings, by harnessing the power of compound interest. Sheehy says more needs to be done to promote this message.
Particular percentage
He says if your retirement fund aims to deliver a particular percentage of your income as pension at retirement after you save in it for 35 years and you reduce the years for which you save by just five years, you are likely to achieve 58% of the targeted pension.
Reducing the number of years for which you save by 10 years will result in you only achieving a third of the targeted pension.
Delaying your retirement or finding employment after retirement can help get you back on track if you started saving too late.
Earning enough to retire comfortably means you need to earn good inflation-beating returns, but beware of destroying your wealth by chasing top-performing funds.
The returns you earn can make a massive difference to your retirement income because the effect is compounded over many years. Sheehy says if your targeted pension depends on you achieving an average return of 10% a year and you achieve only 8%, you will probably be able to realise only 68% of your targeted pension.
But achieving the right return does not mean chasing down the top-performing fund. It typically means finding a fund that will deliver good performance consistently and sticking with it through market cycles.
Van Breda says since the year 2000 investors in the 10 largest multi-asset high and low equity funds in South Africa have achieved anything from 5.3 percentage points to 2.4 percentage points lower than the actual returns (after fees) delivered by these funds over the entire period.
He says on average investors have earned returns that are 3.5 percentage points a year lower than what their funds could have delivered for them. This is a result of switching into and out of funds at the wrong time, which is often a result of being afraid to stay in a (temporarily) underperforming fund and instead chasing top-performing funds.
This 3.5 percentage point difference may seem small, but this means that investors have lost out on 68% of the returns they could have earned if they had stayed put and taken a longer-term view.
Assuming you are investing in one of these funds to achieve its targeted return for retirement, over the 30-year period during which you save for retirement, earning 3.5 percentage points a year less than your targeted return could translate into a pension that lasts 20 years less than it should, he says.