GUIDES: Avoid the trap of running out of retirement capital
A recent survey by the World Economic Forum warns that retirees in six major economies should expect to outlive their savings by between eight and 20 years on average. Closer to home, a Sanlam survey revealed that a staggering 92% of South African retirees do not have an adequate amount of capital on which to live.
Many financial advisers base retirement calculations on the notion that you should retire debt-free and earning an income equivalent to 75% of your final salary. The Sanlam survey showed that the average income replacement ratio in South Africa is closer to 40% of one’s final salary.
When I crunch the retirement numbers for my clients, I don’t assume that they will need any less than they did before retiring. Your golden years should be filled with travel, laughter and - for many - the freedom to spoil your grandkids. Taking care of your health is essential, but we do all age and it goes without saying that your medical expenses will increase. (To further rub salt into this wound, South Africa’s medical scheme inflation rate has increased by 3% to 4% above the Consumer Price Index since 2010.)
Traditionally, many financial planners assumed their clients could release a significant amount of retirement capital by downscaling their homes. The reality is that the property market has slumped and homes are taking longer to sell - a situation that may not change for years. Even if you do manage to sell, the rising cost of moving means you may not release enough capital to justify the move.
Moving costs include capital gains tax on profits over R2million, refurbishing the house and garden for presentation purposes, estate agent’s commission (normally between 4% and 7%), legal fees, compliance certificates, and transfer duty (if you purchase another home).
Let’s crunch the numbers
Financial planners used to do our retirement calculations based on the assumption that clients would live for 25 years after retiring at the age of 65. We now base our sums on a 30-year retirement to account for increased longevity. What’s more, we’ve had to adjust the expected growth rates of retirement funds down from 6% to 4% above inflation to factor in changes in the markets.
Depending on your salary, the table shows how much capital you’ll need to have amassed by the age of 65 to cater for a 30-year retirement. All figures are in today’s terms (and include retirement and discretionary capital).
A couple of ways to skin the cat
If your numbers don’t stack up, I highly recommend you see a Certified Financial Planner now.
Successful retirees make the most of tax-efficient investment vehicles, including pension funds, retirement annuities and tax-free savings accounts. These tax savings will have a significant impact on the returns needed to ensure that long and secure retirement. Do check that you are making the most of this break and contributing at least 27.5% of your income towards the retirement fund. (Be warned that dipping into your retirement fund(s) when you change jobs will undo all this good in a jiffy.)
A well-diversified portfolio that includes enough equity for long-term growth is also essential. Even if you’re approaching retirement, you will likely need to assume some risk to account for longevity.
If you’re relatively young and your home forms the greater part of your total capital, consider downscaling now and investing the savings in retirement funds with sufficient equity for long-term growth. As a rule of thumb, your mortgage contributions shouldn’t exceed 30% of your gross monthly income. If they do, you’re not diversifying adequately and - to put it bluntly - cannot afford the home you have.
Always look on the bright side
Greater longevity is a gift to humanity, but it does mean we have to structure things differently. Securing your financial assets is part of the solution, but it’s also likely that you’ll have to continue working after you turn 65. You can prepare for this exciting opportunity by embracing lifelong learning, keeping up with technology and constantly researching opportunities. Longevity gives you the time to make changes, correct errors and - if you have all your retirement ducks in a row - the chance to give back to society.
Janet Hugo is a director of Sterling Private Wealth and the 2018/19 Financial Planner of the Year.