Retirement planning has a few key factors that can influence the savings target you set and ultimately whether you achieve the income you hope for in retirement.
These are the things you need to think about when you go through the process with an adviser or use the online calculators.
The income you need in retirement
Give some thought to what percentage of your income you could live on comfortably in retirement. Most calculations of what you need to save for retirement will ask you what percentage of your income you want in retirement, or will estimate the percentage income you could enjoy given your current savings and expected future savings.
Employer-sponsored retirement funds typically target an income of between 60% and 75% of your current earnings.
But you may want to live on more or less depending on your circumstances.
The issues you need to consider when deciding if you can live on less are:
Remember that the income you need in retirement may change over your working life as your income grows and your health and family circumstances change.
How long you expect you might live in retirement
How long you expect you might live in retirement is a big assumption you need to make if you are planning to use investments, such as those in a living annuity or discretionary investments, to provide an income.
Financial advisers typically work on 30 years if you are retiring at age 65.
If you retire earlier, the period for which you need to provide for an income is likely to be longer and you will need to save more. Retiring at age 55 and planning a retirement income that lasts until you are age 90, means you need to provide for an income that lasts 40 years – possibly longer than your working life.
If your calculations show your retirement savings are likely to provide an income lower than you wished for, try increasing the age at which you will retire as this has a triple whammy effect:
If you are planning to buy a guaranteed life annuity to provide a pension in retirement, you don’t need to worry about how long you will live in retirement. The risk that you live a long time is one the life insurer assumes for you.
However, remember that the younger you retire, the lower the pension you will get from a guaranteed annuity.
The return on your savings
Any calculation of how much you need to save is based on an assumption about the return you will earn.
When you are still many years away from retirement, you should be invested in such a way that you earn a real (after inflation) return of at least five percent.
Over long-terms – the past 10, 20, 50 and 90 years, South African investors have been able to get this as a real return from a balanced fund that invested about 70% in equities (local and global).
There have also been periods where real returns over shorter periods have been much lower.
If you plan to buy a guaranteed annuity after retirement, you won’t need to worry too much about the returns you can earn after retirement. Guaranteed annuities guarantee you a particular income and only in the case of a with-profit annuity will your increases depend on returns from the market.
However, if you plan to use investments in a living annuity to provide an income in retirement over a number of years, your savings will still need to grow at more than inflation. It is generally a good idea to plan for more conservative returns in retirement as you may need to invest at least some of your savings more cautiously to provide a stable income.
The costs you pay on your savings
It is important to take note of the costs you pay on your savings, especially in times when returns are low, as over long periods of time a relatively small difference in costs can make a big impact on your income in retirement.
However, when working out how much you will accumulate by the time you retire and what pension it will provide you with, you should work on the after-cost returns.
The cost of a pension at retirement
When calculating how much you will need to save in order to provide a certain level of income at retirement, your calculation will either take into account the cost of investing in an annuity or the amount you could safely withdraw from your savings.
Most calculations are based on annuity rates at the time you perform the calculation.
Remember, however that annuity rates, including recommended withdrawals from living annuities, change over time as markets change.
In addition, whichever calculation you use may not be 100% aligned to the pension or income you choose at retirement.
Guaranteed annuities rates are based on bond yields (the interest you earn on a bond relative to the price of the bonds).
You can check a sample of current annuity rates to see how much you can buy a pension for every R100 000 of savings you have here.
Remember to look for an annuity or pension that will increase each year with inflation.
However, you have to make some assumptions in order to get an indication of whether or not you are on track.
When it comes to how much you can draw from your investments in a living annuity, much will depend on how much you have saved, the rate you are withdrawing and for how long you expect to need an income.
The retirement and investment industry often refer to the rule that says it is safe to draw just 4% of your savings each year as an income, but investment cycles and your circumstances can influence this number.
Other expenses you may have in retirement
Consider the savings you may need for the following:
If you receive a large salary increase late in your working life, your expectations of what you will receive as an income in retirement increase – it will be a percentage of a much higher income than that on which most of your contributions have been based.