“How much do I need to retire on?” The answer to this frequently asked question is not a simple one, because it depends on a number of factors, the two most important being your age and your monthly expenditure. However, one can arrive at a rough estimate using a few basic assumptions. Unfortunately, in today’s unpredictable world, these assumptions cannot be taken for granted, but they’re relatively conservative, so at least you have an idea of what to aim for.
Let’s look at two scenarios.
- Scenario A:
- Scenario B:
Tax has not been taken into account. How much you are taxed will depend on the type of investment and how much of your lump sum has come from retirement-fund savings.
Note that these figures would apply to a discretionary or living-annuity investment in which you have a choice of investment assets and decide on the amount to draw as income each year.
In this scenario, your lump sum would need to provide an income to cover your day-to-day household expenses for 30 years (erring on the side of increased longevity), increasing each year by the Consumer Price Index (CPI) inflation rate. My assumptions are that CPI averages 5% a year, your investment returns average 9% a year (giving you a 4% after-inflation, or real, annual return) and investment costs are 1% a year, which takes your real return after costs down to 3%. Your capital will deplete slowly over the 30 years because the returns will be lower than your income withdrawals.
For each R1 of annual pre-tax income you require, you will need to have saved R21. Your initial annual drawdown (the amount you withdraw to live off for the year) will be 4.76%.
This means that, if you are retiring shortly and expect to live off the income for 30 years:
- For a starting annual income of R360 000 (R30 000 a month), escalating each year by 5%, you’ll need a lump sum of R7 560 000.
- For a starting annual income of R600 000 (R50 000 a month), escalating each year by 5%, you’ll need a lump sum of R12 600 000.
You’re in your mid-20s and want to save enough to retire as soon as possible. Again let’s assume inflation of 5% a year. You’ll need to plan for a much longer “post-retirement” phase than in Scenario A. Ideally, you need to have enough capital to ensure that your drawdowns are less or equal to your real, after-cost returns, so it should sustain you indefinitely.
In this scenario you can afford to be more heavily invested in growth assets such as listed shares. Let’s assume that, after costs of 1%, you receive a real return of 5% a year, on average. (Over the last 100 years, the JSE All Share Index has averaged a real return of about 7%.)
It turns out that, at the higher return rate, you’d again need R21 saved for every R1 annual income you require, but your income would be self-sustaining.
It sounds like a lot, but it’s doable if you have a well-paying career, your salary outpaces inflation, especially considering possible promotions, and you take advantage of the tax breaks on retirement fund contributions.
It’s important to note that for retirement funds the minimum retirement age is 55, so if you want to retire before that age you’d need a certain portion of your investments in non-retirement assets.
Let’s assume your salary outpaces inflation by an average of 3%, and you increase your contributions accordingly, by 8% each year. The table shows the lump sum you’ll need at the end of the savings period and how much you’ll have to save to get there.
There is an international movement among young people called FIRE, which stands for Financial Independence, Retire Early. The goal is to save as much as you can when you are young, so that you build up a nest egg on which you can retire by the time you're in your early 40s.
Their approach may seem radical: they recommend putting away more than half of your salary each month. Practically, there are very few of us, particularly now in the face of rising living costs, who would be able to do that.
But if you make the right investment decisions and remain committed to saving a certain percentage of your salary each month (including what is going into your pension fund), your nest egg will grow remarkably quickly so that, although you may not be able to retire in your 40s, by your early 50s you can have saved enough to have the financial freedom that most people only dream of.
*Hesse is the former editor of Personal Finance