If you wanted to stop working now, how much money would you need to live off your savings for the rest of your life? The thought of handing in your resignation tomorrow may seem tantalising, but the amount you need is probably more than you realise, and it largely depends on how far away you are from your “normal” retirement date.
If you are under the minimum retirement age of 55
If you’re between 50 and 55, the short answer is between 25 and 29 times what you will need as an annual income. If you have this much, you can be almost certain that your income will keep pace with inflation and your money will never run out, no matter how long you live. Put another way, the capital amount must be such that you will be able to live off no more than 3.5 to four percent of it a year.
Alex Cook, the chief executive of GCI Wealth, a nationwide financial planning practice, says people planning on retiring at age 50 should withdraw a maximum annual amount of 3.5 percent of their savings, and a maximum of four percent if they are retiring at 55.
Let’s say you’re 55, your house is paid off, you don’t have any other major debt, and your children are out of the house and no longer depend on you financially. If you calculate that you could live comfortably off R20 000 a month (before tax), or R240 000 a year, you would need R6 million (25 x R240 000). If you needed R30 000 a month to live on, you would have to have saved R9 million; for R40 000 a month, R12 million.
These figures assume that the after-costs return on your investment is the inflation rate plus four percentage points, which Cook says is do-able over long periods if you are relatively aggressively invested. (For older people, who need to be invested more conservatively, the calculations should assume a lower return of CPI+three percent).
In other words, at a four-percent annual withdrawal rate (known in the financial services industry as your drawdown rate) and a return of CPI plus four percent, both your capital and your annual income should keep pace with inflation each year.
So, theoretically, if you are 55 with R6 million saved, you will be able to live off R20 000 a month, rising by the CPI rate each year, and there will be a tidy sum to bequeath to your heirs, however long you live.
In practice, you need to factor in a few sobering considerations:
• If you are under 55 and your savings are in a retirement annuity, you do not have access to your money before 55. If your savings are in an occupational pension or provident fund, you will have to resign from the fund and take your benefits as a lump sum, which will be subject to the high tax rates in the South African Revenue Service’s retirement fund lump-sum withdrawal table.
• If you buy a pension (living or guaranteed annuity – see “Definitions”, below) with your savings, you must pay tax on your income at the rates for under-65-year-olds until you reach 65, when the rate drops.
• If your savings are in discretionary unit trust or bank investments or a share portfolio, tax on interest, dividends and capital gains comes into play.
• A drawdown formula that has worked well in the past won’t necessarily work in the future. Who knows what tomorrow will bring? The good returns the JSE has delivered over the past 50 years may not continue indefinitely. In fact, this “golden” period may already have ended, according to some analysts.
• Your life could change in ways you may not anticipate, possibly placing added demands on your finances. For example, you may get divorced or be forced to take care of an aging parent.
• Although expenditure on certain things decreases as you get older (for example, you may spend less on petrol and on your children), expenditure on others increases. It is highly likely that you will spend more on health care, for example. Not only are you likely to suffer more ill-health, but medical expenses are outpacing CPI inflation by at least three percentage points a year.
• You must take into account that you will need money for certain big-expenditure items, such as a new car occasionally.
If you are closer to the upper retirement age of 65
Essentially, the older you are, the more you may be able to draw from your savings because, unless you want your entire capital to go to your heirs, you can afford to let your drawdowns partially deplete your capital – as long as it is done cautiously. If your initial drawdown is higher than four percent, to keep pace with inflation, you will have to draw a slightly higher percentage each year.
Starting with a five-percent drawdown or higher, and increasing your rand amount each year to adjust for inflation, the table below shows how long your money will last at initial drawdown rates of between five and 10 percent on an investment sum of R6 million. The table assumes a more conservative investment return of CPI plus three percentage points. Note that if you are invested in an investment-linked living annuity, the maximum you can draw annually is 17.5 percent, so your money will last longer than indicated, but your income will decline rapidly in the last few years of your life.
Initial drawdown rate
Initial annual income
Years your money will last
Assumptions: Investment of R6 million; constant inflation rate of 6%; constant investment return of 9%; annual income in increased each year by 6%.
Guaranteed annuity: A pension you buy from a life company, which guarantees you a fixed income (which may be inflation linked) for the rest of your life. Apart from an optional capital guarantee for, say, the first 10 years, there is no capital for your heirs when you die.
Investment-linked living annuity: A pension you buy on an investment platform. You take responsibility for the performance of your investment, which may, through the platform, be in unit trusts and exchange traded funds.