Retiring early is tempting, but can you afford it?
The temptation to retire early and adopt a life of leisure can be particularly alluring as you enter your 50s and 60s, particularly after many years spent with your nose to the grindstone.
But can you afford it?
Two main drivers determine whether early retirement is even an option for you. They are:
* How much capital you have.
* How much you need to draw to sustain your standard of living.
Clients often ask, “How much capital will I need to retire?” The answer is directly related to how much you require on a monthly basis to sustain your current standard of living.
One of the basic calculations is to take your current monthly expenditure, divide this number by four and multiply it by R1000. This calculation works when you are still trying to accumulate your capital and need to set a retirement savings target.
If you are already at retirement age, however, ensuring that your capital will last your entire lifetime, which is generally unknown, becomes more important. To be conservative, I would suggest that you draw no more than 4 percent of your retirement capital on an annual basis.
To demonstrate the significance of this, the graph shows how withdrawal rates affect how long your capital will last. The graph is based on the example of an individual who retires at 55 years with capital of R10 million, and further assumes that inflation rises by 6 percent a year and that their investment achieves annual growth of 8.5percent.
By keeping their withdrawal rate to 4percent, their retirement capital would sustain them until the age of 95. However, by increasing their withdrawal rate to 4.5percent, their capital would be depleted by the age of 87. A 6 percent withdrawal rate would mean that their capital would run out at the age of 77 - nearly 20 years earlier than if they had stuck to 4 percent.
The exponential benefits of delaying retirement on savings
If a 4 percent withdrawal rate will not provide you with sufficient income, it may be worth giving serious consideration to delaying your retirement.
Remember, your salary and, therefore, your retirement contributions are usually at their peak in the years just before your retirement, and when combined with the added effect of delaying dipping into your capital, these last few years can make a huge difference to your portfolio through the power of compounding.
To demonstrate the enormous impact of an extra few years on your savings, the graph compares three scenarios involving the same investor who has accumulated a R10m capital lump sum at 55.
1. Retires at 55 years. In the first scenario, the individual retires at the age of 55 and chooses a 5 percent annual withdrawal rate. Assuming that inflation rises by 6 percent every year and that their investment achieves growth of 8.5percent, or 2.5percent after-inflation, their capital would be depleted at the age of 83.
2. Delays retirement until age 60, does not add to capital. In the second scenario, the individual delays their retirement for five years, or until the age of 60. However, instead of working full time, they choose to slow down and cut back on their hours, meaning that they earn sufficient income only to cover their monthly costs. They do not add or withdraw any amounts from their retirement pot during this time, but their capital continues to achieve real growth of 2.5 percent.
Even without making any additional contributions, by delaying their retirement and simply allowing their capital to grow for an additional five years without eating into it, their retirement savings will comfortably last until the age of 94 - even assuming the same 5 percent withdrawal rate, but at a later date, as the first scenario.
3. Delays retirement until age 65, continues to save. In the third scenario, the individual continues to work until the age of 65 and keeps contributing towards their retirement savings in order to increase their capital base to a greater degree. Assume that this individual adds R5000 a month to their investments while still working, and that the capital also sees real growth of 2.5 percent a year, their capital base will grow to more than R11.5m by the time they retire at 65 - a R1.5m increase in real terms from the R10m with which they would have retired if they had retired at 55.
Given the increase in their retirement capital, the individual draws down only 2.5 percent a year on their capital for their income, increasing this amount by 5 percent each year to keep up with inflation. This means that their capital would last until they are 105 - today, a more likely age for the individual to reach than the 83 years outlined in the first scenario.
It’s therefore vital to make sure that you’ve done all the proper planning and calculations before you take the big step, not forgetting to add a buffer for emergencies or unexpected expenses.
It’s important that you don’t rush such a big decision, and take the time to consider all the implications before you opt to retire early.
For instance, you are most employable when you are already employed, so it could be difficult to re-enter the job market in 10 years if you realise that your money may be running out. Also remember that advancements in medical technology and healthier lifestyles mean that people are increasingly living to 90 and even 100.
However, if you are desperate to escape the daily grind, rather consider cutting down your working hours or look for a less strenuous position, even at a lower salary, simply to cover your current living expenses and avoid falling back on your savings.
Kerry King is an advisory partner at Citadel