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By Mags Heystek*
Saving enough for your retirement is only half the battle of securing a comfortable retirement. The second half – once you’re in retirement – can easily become a brutal fight against the rising cost of living constantly wearing down your limited funds.
Whereas you spent your working years trying to save enough for retirement, your priority now shifts to making your savings last for an indeterminate period. With many retirees living into their 90s, you could be in retirement for as long as you’d worked if you retire at 55.
So, the reality is that you need to plan for the long haul, even if you don’t live to a ripe old age. And with inflation having risen so steeply in the past two years, many of your assumptions about your future costs could leave you short.
You and your money in retirement
In truth, these assumptions about the future needn’t be a mystery. Even with higher inflation and longer life expectancy, there are a few handy benchmarks to help remove absolute uncertainty.
Take for example the accepted rule of thumb that you should be able to live comfortably if you’ve saved enough to provide a monthly pension equal to around 70% of your current income. That figure is a decent goal to aim for, although your circumstances might be different.
The only proven way to get a more accurate picture is to sit with someone qualified to help you produce realistic projections and assumptions. Your financial advisor is ideally suited to this role as they can assess your current position and draw up a plan that accommodates factors such as the future cost of living.
The biggest challenge you face in retirement is that your resources are now finite, with opportunities to generate extra income not always guaranteed. So, if you don’t plan and budget carefully you might outlive your savings.
Budgeting priorities in retirement
Working with your financial advisor, I suggest that you plan for your retirement spending even before you’ve entered retirement. This will help give you an idea of what you’ll be able to afford out of your savings as you get older.
Factors that influence this picture include how much you’ve saved, whether you’ll be able to generate extra income in retirement, the expected inflation rate and how much you want to draw from your savings every year.
It’s essential to strike a balance between your spending and your available funds if you hope to not outlive your retirement savings.
Read also: Decade-by-decade: how to save for retirement
Your expenses will be paid from the monthly pension you receive, which is directly linked to how much you’ve saved. South African retirement laws allow you to draw between 2.5% to 17.5% of your investment balance.
In theory, the higher your balance of available funds the more you can draw. The question is: what’s the right amount?
Let’s look at the following example of how your savings are affected by different withdrawal rates if you have retirement savings of R6 million when you retire at 55.
In the first example we’re assuming you withdraw 5% (R25 000 per month gross income before tax), with inflation at 5.2%. To keep up with inflation, we’re assuming you increase your withdrawal amount at the same rate.
Figure 1 (below): 5% income adjusted with inflation at 5.2% per annum
Figure 2: Annual drawdown scenarios at 5% income
*Based on an annual return of 8% net of fees
As you can see, even withdrawing what seems a small sum (only 5%) could leave you in a position of dwindling income by the age of 77.
Conventional wisdom today dictates that a rate of 5% is simply too high if you live beyond your 80s, especially if inflation remains high for longer than anticipated.
By contrast, you can see the marked difference in outcomes if you use the same scenario sketched earlier, but only draw from your savings at 2.5% per year.
Figure 3: 2.5% income adjusted with inflation at 5.2% per annum
Figure 4: Annual drawdown scenarios at 2.5% income
Please note: The cash flow scenarios are for illustrative purposes only.
Let’s be realistic for a second
The truth is most people today are not retiring at 55. It’s much more realistic to expect a retirement age of 65, even 70 in today’s day and age, and this means that investors have more time to contribute to retirement savings. According to the OECD, the average age of retirement for Males globally is 64.
Source: Bloomberg.com; OECD (Organisation for Economic Co-Operation and Development)
Source: Bloomberg.com; OECD
Tips to make your money last
My advice to clients is therefore to always have a clear idea of how much you’re drawing and how that is influenced by your investment returns and inflation.
The first step you can take to make your savings last through your retirement is to reduce your withdrawal rate, with 2.5% a good target to aim for.
One way to reduce your monthly expenses in retirement is to eliminate your debt. You might also be able to explore ways of supplementing your pension – whether through annuity income like rental or doing consulting work linked to your work experience.
I’m not suggesting you forgo retirement and work until your last breath; that’s not exactly what retirement is about. But it’s always good to explore your options, which is easier when you understand your current position and know what to expect in the future.
No-one has a crystal ball that shows you precisely what’s to come, but your financial future doesn’t have to rely on guesswork. And you’ll be far better prepared for the literal battle against the cost of living in retirement if you know how and how much you can spend in your golden years.
- Mags Heystek, CFP® is head of Brenthurst Sandton. [email protected]