For many individuals the mere thought of retirement planning can be overwhelming, if not frightening. Experience has taught us – the financial advisory fraternity – that such feelings are not always without reason.
To live out retirement in style, comfort or even just in contentment requires effort and forethought. Furthermore, each individual must consider a lot of complex and unique risks specific to his/her circumstances. And with expectation and risks come many misconceptions about planning, preparation and timing.
The underlying truth is that there’s rarely a one-size-fits-all approach. Even general guidance that applies to most South Africans might not apply to a particular individual, or several notable exceptions could emerge as time goes by, or be triggered by a specific event.
While some retirement planning questions are known to be situational, there are others that are too commonly taken to be fact.
Financial advisors can play a huge role in dispelling these myths and better preparing investors for when that time comes, but also in making sure that they are properly covered for a rainy day.
But let’s start with differentiating some of the most important facts from fiction:
Fact 1: It is not just about achieving a simple savings goal
No matter what number you have in mind, it is probably going to be wrong. Being financially willing and able isn’t about achieving some arbitrary savings ambition. It is about having put enough away to maintain your desired lifestyle in retirement.
In other words, how much you need is driven by how much you plan to spend, not the other way around.
Fact 2: Don’t assume your expenses at retirement will be less than during your working years
While it is true that when individuals stop working they no longer have to make contributions to a pension fund or spend as much on petrol (without the daily commute), it’s a misconception that you’ll have lower expenses. The aforementioned ‘savings’ will be absorbed by higher medical expenses, visiting children in far-off places, or another above-inflation hike in administrated costs, like water and electricity.
When planning for retirement, most individuals want to maintain their current lifestyle, not reduce it. Replacing annual earnings requires significant and ongoing dedication to this specific goal.
Fact 3: Contributing the maximum annual tax-deductible amount is a must, but not enough on its own
Allocations to a pre-retirement fund is a great way to build wealth and reduce your taxable income in a specific year, but for individuals in higher income brackets, it won’t typically fund the lifestyle they have become accustomed to at retirement.
South African investors are entitled to a tax deduction of 27.5%, subject to various conditions and limited to an overall monetary cap of R350 000 per annum. This cap will be reached where a taxpayer contributes the maximum 27.5% and the higher of annual remuneration or taxable income is equal to R1 272 727. Even with a long-term horizon until retirement, these savings alone likely can’t replace an annual seven-figure income.
For example, Susan is 35 and saves R29 166.67 per month (equating to R350 000 per year) in her retirement annuity (RA) until she retires at age 65 (we’ll assume she only started contributing to her RA at 35). Her investment earns an average return of 8% each year (before and after retirement). Susan expects to live until age 90. Based on these figures, Susan’s RA savings could provide just over R30 820 monthly pre-tax income in retirement (in today’s rands) which would increase 6% each year (assumed inflation).
Investors should look to save beyond these allowable contributions and should consider contributing towards a tax-free savings account (to a maximum of R33 000 a year) as well as other discretionary investment portfolios and endowment structures. In addition to boosting retirement savings, these types of investment vehicles offer several other benefits, including flexibility and tax diversification.
Fact 4: Working beyond retirement might fill the funding gap, but isn’t always possible
Although it may be possible to graft beyond the age of 70, there could be external factors outside of your control which could dampen your plans. Unforeseen changes to your health or that of your spouse may inhibit your ability to keep working.
The risk is increased for individuals whose occupations require them to be physically present and/or restrict them from working remotely, e.g. doctors or nurses, tradespeople or lecturers/teachers.
Even if these restrictions don’t apply, the risks around job security still exist. There is always a possibility that a company will downsize, and it is not uncommon for longer-standing and senior employees – who usually command higher remuneration – to be first in the firing line.
Well-paying part-time jobs are few and far between, or will be more demanding than the one-day-a-week schedule envisioned by many retirees.
Fact 5: You can still have a bond on your house in retirement
Pre-retirees are often hesitant to carry debt into retirement, but the leverage can pay off if you have an attractive interest rate. Whether you’re considering downsizing and buying your new home cash, or prepaying the loan on your current home, weigh the benefits of being debt-free with the opportunity cost of not having the cash available for other purposes, such as adding to an investment portfolio.
You should also consider how long you plan to live in the home, any additional cash needs you foresee, and what other financial resources you may have to bridge the gap if needed. Every investor requires liquid assets, and that flexibility is worth something.
Fact 6: People are living longer – which usually means a retirement portfolio must last longer too
It’s not uncommon to be wary of market volatility at retirement. The idea of tapping your financial reserves can be unnerving, and conventional advice often dictates a risk-averse portfolio with high exposure to bonds for example. But that isn’t always appropriate for every investor.
Fixed-income instruments like bonds are considered safer than equities, because their performance is less erratic and they provide a guaranteed income. However, as retirees look harder for ways to reduce risk, they should also consider what returns they require to match their future income needs.
Financial planning and investment advice require a highly personalised approach and should be customised to each individual’s situation and goals.
Before taking any broad-based retirement planning advice to heart, work to understand the underlying rationale and assumptions to ensure it is appropriate for your circumstances.
Also keep in mind that tax laws and financial strategies change over time – even year to year. To help ensure you stay on track for retirement, you will want to periodically review your strategy, including your spending and savings rate.
In view of the many issues to consider, it is advisable to consult a qualified, experienced financial advisor to guide you.