In a recent Business Tech survey conducted in January 2022 among 2 702 readers, the majority indicated that they save less than 15% of their salaries (76% of respondents) while 35% indicated that they don’t save at all. This means many South Africans will not be able to retire (or else, have to lower their standard of living considerably) as there will not be funds to rely on. This scenario usually paints a gloomy picture, as people will have to work for longer or become dependent on their children – the so-called ‘sandwich’ generation.
Given advances in the medical field and healthier lifestyles, we can also expect to grow much older than a generation or two before us. So, the risk faced by many is outlasting their retirement savings. This is called longevity risk – the risk of outliving your money and running out of retirement funds at an advanced age.
Income replacement percentage
It is generally accepted that the ideal retirement income is about 75% of your final salary. Mariska Comins from PSG Wealth’s Technical Department says according to National Treasury’s research, only about 6% of South Africans meet this target.
The following are considered general guidelines to reach the 75% replacement target:
- Age 25 – contribute 15% of your salary to retirement provision.
- Age 35 – contribute 24% of your salary to retirement provision.
- Age 45 – contribute 43% of your salary to retirement provision.
- Age 50 – contribute 60% of your salary to retirement provision.
The bottom line is to start contributing as early as possible and as much as possible towards retirement. The later one starts saving, the more difficult it becomes to reach the ideal replacement percentage, as a shorter period reduces the impact of compound growth.
What are the reasons why South Africans are not making enough provision for retirement?
There are various reasons. Firstly, the country has an unwelcome record of the highest unemployment rate in the world, as can be seen in the graph below.
Secondly, South Africa’s interest rates, including interest rates as a percentage of GDP, are among the highest across the globe. With about five million taxpayers the tax base is very small, and ongoing tax increases have an impact on individuals’ free cash flow.
Income tax as a % of GDP
The Covid-19-induced lockdown measures have resulted in additional increases in unemployment and already high debt levels, forcing individuals and once-thriving businesses and enterprises to close their doors permanently. Apart from high levels of unemployment, South Africans also have to deal with high levels of debt.
South Africans generally have large debts. In recent research, Debtbusters, a debt counselling company, found that South Africans earning more than R20 000 a month spend up to 65% of their net salaries just to settle debt. Their average debt to income ratio is 146%.
Therefore, it is evident that South Africans struggle to save adequately for retirement, due to the various factors mentioned above and others.
How much capital is required for a meaningful retirement?
For individuals who do manage to save, it is sometimes also sobering to realise how much capital is really required to fund a meaningful monthly income. It is seldom possible for investors to replace their salaried income with income from retirement funds.
In pre-retirement planning, we work with 75% of the salary as a starting point. Let’s use an example. Simon is 65 and about to retire. His pre-retirement salary is R50 000 (net of tax) and he wants to receive at least 75% of his salary as a monthly pension. The pension payout should annually increase with inflation to maintain the purchasing power of his income. It must be sustainable until age 90. We calculate how much capital he must have to fund this cash flow requirement.
At age 65, a sustainable withdrawal percentage is usually 5.5%. This means a pensioner can withdraw about R4 250 per month per million, which will be sustainable for the next 25 years to age 90. This amount includes an annual inflation adjustment to protect the purchasing power of the income.
For Simon to receive R37 500 per month after tax he needs to have at least R7 300 000 in retirement funds. If he would like to draw an income equal to his last salary, the capital requirement increases to R9 750 000.
We know the impact of daily challenges on our ability to save for retirement. Not to mention the devasting effects of Covid-19.
However, it is important to start saving as early as possible, with a proper savings plan, to take advantage of compound growth – which Albert Einstein called the eighth wonder of the world.
Here is an example of the power of compound growth at work (simplified for illustrative purposes, thus ignoring factors such as choice of funds, market volatility, etc.):
Anne starts saving at age 22. She contributes R3 000 a month to a retirement annuity and at age 30 she stops all contributions.
Jack only starts saving at age 30. He also contributes R3 000 a month to a retirement annuity, but he keeps on saving until age 65.
Anne only saved for eight years and her total contributions were R288 000.
Jack’s contributions from age 30 to 65 amounted to R1 296 000.
Anne earned about R13 500 000 in her retirement annuity, having saved a capital amount of R288 000 over the eight years.
Jack earned R12 600 000 in his retirement annuity, but the capital he invested amounted to R1 296 000 over the years. That is four and a half times more than Anne’s investment.
Gerry saved R3 000 a month from age 22 to retirement at 65. Over this period, he saved R1 548 000, but he has R25 700 000 available at age 65.
This illustrates the power of compound growth.