Retirement: How much is enough?

It is probably the question financial advisors and retirement educators get asked most: How much money do I need to sustain my lifestyle in retirement?

It is a straightforward question, but unfortunately it depends on so many variables (many of which will be dependent on individual circumstances) that the answer is not so straightforward.

Research suggests that a capital sum of 17 times a person’s final annual salary before tax will produce an income equal to about 75% of the last salary if the individual retires at age 65, Jeanette Marais, director at Allan Gray, says.

She cautions however that the model makes a lot of assumptions, and that living off 75% of your salary can only work if you don’t have a mortgage when you retire and are debt-free.

The calculations also assume that people don’t have any dependents they still need to support in retirement and that they are able to reduce their living standard to some extent.

“The capital amount of 17 times will also only be enough if you keep on earning real returns right through your retirement [and] if you withdraw sustainable amounts when you start to draw an income.”

Investors would also have to avoid some mistakes along the way.

To be on track to reach a capital amount of 17 times at retirement, an individual would need to have saved an amount of two times her annual salary after working for ten years and ten times her annual salary after working for 30 years.

This is a tough ask, particularly in a low-return, difficult economic environment and against a background where many people focus on immediate, rather than long-term goals – sometimes out of necessity.

“In my mind the greatest destroyer of retirement capital is the fact that more than 80% of South Africans today take their retirement savings when they change jobs.”

This means that they restart their savings pot, potentially shorten their savings horizon and lose out on a significant amount of compound interest over time.

Where investors only start saving at a later stage, they would need to save significantly more to be in the same position at retirement (see table below).

Source: Allan Gray

But Mike Wilmot, head of investments at Nedbank Private Wealth, warns that the number of 17 “may or may not” turn out to be correct based on how the reality differs from the assumptions.

More importantly perhaps, whether the number is appropriate, will depend on the specific factors affecting the individual.

Conceptually, the methodology is correct, adds Winston Monale, managing executive for wealth management, global investment and solutions at Barclays Africa Group, but the assumptions may prove difficult to achieve in real life.

Getting a return of 10% in the current environment is extremely difficult, he adds.

Moreover, the reality is that only a very small portion of South Africans can sustain their standard of living in retirement.

“Somewhere around 5%-6% of retiring individuals actually are financially independent,” Monale says.

Even among high net-worth individuals, the retirement savings numbers don’t necessarily inspire confidence.

Monale says the average salary in the private banking division is roughly around R1 million per annum.

According to the model, these individuals would have to have saved roughly R5 million for retirement by their early forties.

“That is not the reality that we find.”

While the assumptions may prove difficult to adhere to in reality, “this kind of approach” that tries to commit people towards a savings plan “is a good one”, Monale says.

Although the numbers may look staggering and feel impossible to achieve, perhaps the more important discussion South Africans should have is how to set themselves up for “unretirement”, a world where they continue to work and contribute after the age of 65, although this work may be something different to what they did before, and may not toe the line of an 8-to-5 schedule.

Wilmot says the two-stage model of work, where an investor accumulates money while working, retires, and draws down the capital is arguable outdated.

The move from defined benefit to defined contribution funds and greater life expectancy have led to structural changes in the retirement industry and investors will likely have to rethink their approach.

Wilmot says a retirement age of 65 is no longer realistic.

“I think it is important not only from a financial planning perspective, but also from a wellbeing and a general sort of advisory perspective, that you want to be productive. You want to invest into your human capital and you want to be able to draw on that investment perhaps post formal retirement in a corporate.”

This has a major bearing on how much money an individual will need.

A phased retirement could also help significantly in the event that there is a major market correction or protracted bear market around the time that someone retires, which may increase the risk of running out of money significantly.

“People do need to and should work for longer,” Wilmot adds.

Marais says if an investor could postpone retirement by only five years, the individual can score almost 15 years because they earn an income for five more years, contribute to their pension fund for five more years and have five fewer years to live off the income.

While numbers could provide a baseline for people to work towards, there are many things investors can do to work around that, she adds.

For the best chance of achieving your retirement goals, there are some basic principles that can help.

The first is to implement a proper financial plan for short-, medium- and long-term needs, she says.

The second is to start saving as soon as possible (if you haven’t already) in order for compound interest to work its magic.

The third is to realise the importance of real returns – returns in excess of the inflation rate.

“If you do not earn real returns from the moment you start, right through retirement – and don’t get too conservative when you get to retirement age – you will not be able to reach these goals, because inflation is going to be your biggest enemy,” Marais says.

The fourth is not to time the market or to switch investments in an effort to chase returns.

Finally, it is important to construct a well-diversified portfolio with sufficient risk and volatility protection.

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