RYK VAN NIEKERK: Retirement is a critical event in anyone’s life and it’s vital that when you retire one day that you have accumulated sufficient assets to live comfortably. Unfortunately very few South Africans are able to do so due to a variety of reasons. Joining me on the line is Jaco van Tonder, he is the advisor services director at Investec Asset Management, and today we are going to discuss the general problems facing retirees. Jaco, welcome to the show, why are so few individuals and households able to retire with a lifestyle that they are accustomed to?
JACO VAN TONDER: Hello Ryk and hello to the listeners as well. That is quite a loaded question that you ask and I think there are many, many different drivers but I think one can break it down into two main drivers. I think the first one is the fact that we live in a world today where we are not being told and we are not being forced to save for retirement. Most people, even if you work for a company and you belong to a company’s pension fund, you still have options around how much you want to contribute, and from first-hand experience, which we’ve seen in many companies across the industry, general employees tend to submit very low contribution levels if they work for a large corporate.
It’s actually not unusual to see a vast majority of people in a firm contributing only 5%, 6% or 7% of their salary towards saving for retirement. The reason they do that is because I think as an industry we have not yet drilled into peoples minds the importance of having a much larger contribution rate from very early on in their career. If we think back to our parents, who worked at a firm and belonged to their pension fund, and were forced to belong to the fund and the fund had a fixed contribution rate and that’s what was deducted from your salary. There was no such thing as options, you couldn’t decide what you wanted to invest in; everything was prescribed.
Now, as funny as that might sound, in that prescribed environment the benefit was that people at least saved for retirement. In today’s environment where you’ve taken a lot of those prescriptions away, you are leaving people open to choose and unfortunately the facts are telling us that people are not choosing wisely. So they are not investing enough and they don’t realise that they are not investing enough because there are few ways today that people can easily assess whether they are saving enough. It’s actually a difficult question. So my own response to people generally would be if you’re not saving at least 15% of your salary every month, you’re not saving enough.
How much is enough?
RYK VAN NIEKERK: It sounds daunting that some people may not know that they are not saving enough but how do you know that you have saved enough at retirement to sustain your lifestyle?
JACO VAN TONDER: Ryk, my response to people who ask that question typically consists of three bullets and number one is always try to make sure that you are saving 15% or more of your salary, even if you start out working very young. That’s the first step. The second step is don’t take any of that money away, don’t cash in your retirement fund if you change jobs, try to preserve it as far as possible. The third one is as you reach a slightly more advanced age and you get into your 40s or your 50s, the question is how much capital do you need for the income level that you’re looking for.
That slightly older group of people, where the amount of capital is really the question. As opposed to how much I’m contributing, the calculation I normally give to people is to say work out how much money you need before tax to live off if you were to retire today and divide that number by 5% or multiply it by 20% and that’s really the simple rule. So take that income, multiply it by 20% and that is the capital amount that you would need if you were retiring today to give you that level of income, plus inflationary increases for around a 25- to 30-year period. That’s how much you need.
RYK VAN NIEKERK: But you cannot only do this at retirement, for most people it would be too late and you need to do this a lot earlier, is there a rule of thumb to measure your readiness to retire prior to retirement.
JACO VAN TONDER: Ryk, once people have not saved from early on in life, everyone’s calculation becomes different and then you probably need some type of online tool to start giving you an idea of how much you need to save to reach certain capital levels.
So my rule of thumb for people is that you need to get to that level of around 20 times whatever it is that you want to draw and early on in life you want to be saving 15% to 20% of your capital. If for a long time you haven’t saved anything, and then you want to start saving again or you’ve used your retirement capital to start a business and maybe that business didn’t work out, and you’re joining the employment workforce again, I would suggest a good conversation with a financial advisor who can help give you clarity.
There’s no simple rule of thumb in those complicated situations. But the reality is for most people we need to save more than we are currently saving and that’s the mindset almost with which you want to approach this problem. If you then want more detail, some retirement funds have tools to calculate your deficit or otherwise a conversation with a decent financial advisor will quickly highlight this for you.
Common retirement savings mistakes
RYK VAN NIEKERK: What are the most common mistakes that people make regarding their retirement? Is it just not saving enough or are there other mistakes that will have an impact on the quality of life after retirement?
JACO VAN TONDER: There are a number of issues and I think we focus on the not saving enough part because, in our view, that’s probably the biggest problem and if you don’t solve that problem then solving the other issues doesn’t really move the needle.
So let’s assume for the moment that someone is, in fact, saving enough on a monthly basis and has been doing so for quite a long time, there are other risks they’ve got to watch out for as well. We’ve mentioned one of the risks, which is to cash in your retirement fund when changing employers. It’s a unique South African phenomenon that we are allowed to cash in our retirement funds when we move from one employer to another, most other countries in the world you can’t do that. So please don’t cash in your retirement fund when you change employer would be the second one.
The third one is when you’re selecting your investment portfolio because in today’s modern pension fund schemes we all have the option to pick what we want our funds to be invested in. Make sure that you don’t pick conservative funds, especially when you are still young. I would say pick the highest equity exposure portfolio that you can find if you are in your 20s and 30s, and even 40s, to allow the real growth to come through in your portfolio. So investing in conservative funds is a mistake that people often make because they’re afraid of market fluctuations.
Number four is to think carefully when approaching retirement in terms of what to do with your portfolio allocation, depending on which income products you want to purchase. I guess a lot of the work that we’ve done at Investec in the last year has focused on this interaction between your investment portfolio before you retire and in what type of income product you are retiring. For example, are you buying guaranteed annuity from a life insurance company or are you going to be just investing your retirement assets in a living annuity and managing your own portfolio and drawing your income without an advisor’s help? This actually makes a big difference to how you construct your portfolio in that last five or six years before retirement and sometimes people make mistakes there as well. They go for a fixed-income money market portfolio in the last three or four years before retirement but then they want to purchase a living annuity after they retire, so there’s a bit of asset allocation matching that needs to happen and people often make small mistakes in those as well. So those I would highlight as being the four most common errors that people make.
RYK VAN NIEKERK: Jaco, in most cases, a financial advisor would choose those funds on behalf of their clients. Their clients do not actively play a role, so if the choices are too conservative the blame should then be on the advisor?
JACO VAN TONDER: Ryk, I think pre-retirement someone is still moving towards the date when they want to retire, so they’re still investing in a pension fund or a retirement annuity or any one of those accumulation products. The investment portfolio structuring is fairly simple and I would say the rule of thumb is to go for the maximum equity exposure in a retirement fund, which under Regulation 28 is roughly 75% in growth assets and that’s as simple as the solution should be.
So there’s no rocket science involved before you retire and that’s why I think many people on their own pension funds just pick the options that are selected and those options tend to be 75% equity options. So as long as they do that and they don’t pick a cash fund everything should be fine. It gets a lot more tricky once you get to the retirement date because the cash flows and the complexities of the problem becomes a lot bigger once someone wants to live off a pot of capital and draw an income on a monthly or annual basis.
I think in our experience, depending on what retirement income product you pick, an advisor can be a critical component of the solution. If a client decides to put all of their assets into a guaranteed annuity and get a fixed payment from a life insurance company for the rest of their life, the classical guaranteed annuities of, say, a 6%, 7% or 8% annual increase with a spouse benefit, there is very little complexity in that and there’s no ongoing management or the need for an advisor to help manage that solution.
However, if the client selects a living annuity, invests in a portfolio of assets, starts withdrawing 4% of the capital as income, has to annually increase their income, and watch their portfolio then in that particular scenario, there are a lot of complexities and risks that the pensioner could be exposing themselves to.
Generally, our advice to people in living annuities is to get a financial advisor. There are a large number of interesting subtleties that have come out of our research that show that living annuities are sensitive to a number of market risks. Obviously, if you buy a guaranteed life annuity the insurance company takes care of all of those market-related risks and the pensioner doesn’t have to care about it or worry about it. But if you have a living annuity, all of those market-related risks are now a risk directly to the pensioner and the pensioner has to in some way manage them and that can be quite difficult to manage on your own. So I would say for good financial advisors a retirement annuity is in many cases a requirement.
RYK VAN NIEKERK: We’ll have to leave it there. That was Jaco van Tonder, he is the advisor services director at Investec Asset Management.
Brought to you by Investec Asset Management.