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By Leslie Greyling*
These scenarios below are likely familiar to many.
- It is too late to start saving for retirement, so there is no point in starting to save at all.
- You changed jobs and cashed in your retirement investment.
- The array of investment vehicles is too overwhelming, and you do not know where to start.
For many South Africans, the information overload around retirement is overwhelming. In reality, it is a simple equation: what you will be spending in your retirement dictates what the total amount is that you will need to save towards.
Before becoming overwhelmed with the “what ifs”, which typically include: the age you decide to go on retirement, how many years you will live, future rate of inflation, likely future returns on your investments, start with a careful plan, which is the best you can do in determining how much is enough for your retirement.
There are two best practice models you can apply, and both begin with a budget of what your expenses in retirement will be. Once you have the total, you can calculate how much you will need to cover those expenses for at least 20 or even 30 years, without running out of money.
The 5% rule
Initially set as the 4% rule to ensure retirees would not have to face the prospect of outliving their savings, most financial advisors now agree that you can safely work on a withdrawal rate of a maximum 5% of total savings. If, however, you go on retirement earlier, for example at age 55, an income withdrawal percentage of 4% and lower would be advised. Sticking to a 4% to 5% withdrawal rate, will ensure that a) your capital growth will beat inflation and you draw a monthly income which is sufficient to live from.
A retirement plan laid out in accordance with this above rule would fall into what is termed a Living Annuity – meaning any capital remaining at your death will be paid out to nominated beneficiaries.
Easy way to calculate the retirement capital needed:
You require R20,000.00 pm income for retirement.
Annual income required is R20,000.00 x 12 = R240,000.00.
To calculate your capital amount, divide R240,000.00 by 5%, giving you R4.8m.
You require R25,000.00 pm income for retirement.
Annual income required is R25,000.00 x 12 = R300,000.00.
To calculate your capital amount, divide R300,000.00 by 5%, giving you R6m.
You require R40,000.00 pm income for retirement.
Annual income required is R40,000.00 x 12 = R480,000.00.
To calculate your capital amount, divide R480,000.00 by 5%, giving you R9.6m.
The above calculation does not take income tax into consideration. It further goes without saying that market conditions could easily influence this equation. Stock valuations and inflation are both important metrics that could impact the 5% rule (both positively and negatively), but as mentioned above, start with your estimated retirement needs, and build towards your goal.
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Going with Fixed
An alternative strategy would be to purchase a Fixed or Life Annuity product at retirement, where your income is guaranteed for life. This product can be structured to suit your needs.
Important points to consider include changing annuity rates, these Life Annuity Rates change weekly and can be very different at retirement age.
Option 1: Single Life Annuity: income is provided to one person for life, even if death is at age 102.
Option 2: Joint Life Annuity: income is paid to the first annuitant and on their death will continue to be paid to the second annuitant until death.
This income or annuity rate considers age, gender, mortality rates (for example, women outlive men, on average), and whether the income must increase annually. It further also considers the current interest rate cycle, it will for example not be a good time to purchase a life annuity in the current low interest rate environment.
Unlike the Living Annuity enjoyed with the 5% rule above, a Fixed or Life Annuity product leaves no capital value that can be paid out to beneficiaries upon death, thus making it preferable for individuals who do not have dependants to whom they want to leave money when they pass away.
Below is an illustration of the upfront investment required on retirement to secure a monthly income, at current annuity rates. Note that the female’s income is lower than the male, because females have a longer life expectancy.
|SINGLE LIFE ANNUITY|
|5% annual increase in income|
|10 year guarantee period for this example, a guarantee period of up to 20 years can be selected.|
|( if you die during the guarantee term the income will continue to pay to beneficiary for this period )|
|For illustration purposes. Based on current annuity rates. Tax rates based on 2021 tax tables|
|Male aged 60||Female aged 60|
|R 2,4 million:||R 15 443 gross income pm||R 14 608 gross income pm|
|after tax R 13 973 pm||after tax R 13 288 pm|
|R 4,8 million:||R 30 914 gross income pm||R 29 244 gross income pm|
|after tax R 25 489 pm||after tax R 24 336 pm|
|R 6,0 million:||R 38 649 gross income pm||R 36 562 gross income pm|
|after tax R 30 826 pm||after tax R 29 386 pm|
Whichever you choose, start with the end in mind. This first step will allow you to start building towards a structured retirement income.
Read more about retirement planning.
- Leslie Greyling is a financial advisor at Brenthurst Wealth Fourways office. [email protected]
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