The importance of retirement planning
Why plan for retirement?
The reality for most individuals is that they will spend between 20 to 30 years in retirement. These years need to be funded by an average work life of between 40 to 45 years. Given the uncertainties of life and the continuous rise in the cost of living, we need to maximize the opportunity of building up sufficient capital for retirement during our active working years. This requires a holistic investment and savings plan for your in-retirement phase.
Failing to save enough for retirement
There are a few main reasons why individuals fail to save sufficiently for retirement. Ask yourself these questions, and then address these issues as you continue reading.
Are you unable to save due to your income not being sufficient to meet your basic needs?
Have you waited too long before starting to save for retirement?
Are you driven by the consumer mindset of 'what I want' rather than 'what I need'?
Have you saved enough of your excess income?
Do you have the appropriate investment strategy?
Are you dipping into your retirement savings before retirement?
Is the cost of living rising by more than your income earned?
Do you lack general financial knowledge and skills?
Achieving financial independence
Financial independence is your ability not to have to rely on the financial support provided by others. This means that you are able to generate enough passive income from your retirement capital in order to meet your daily living expenses.
Apply these 7 principles in order to give yourself the best chance of achieving financial independence:
Principle 1 Start saving as early as you possibly can.
Principle 2 Develop a budget that enables you to save for retirement.
Principle 3 Create a retirement plan with short-, medium- and long-term income and capital goals.
Principle 4 Seek specialist assistance from a Financial Adviser to develop and maintain your plan.
Principle 5 Design an appropriate investment strategy to match your financial objectives.
Principle 6 Continuously enhance your knowledge relating to savings and investments.
Principle 7 Preserve your retirement capital when changing jobs.
How much is enough?
The most frequently asked question from individuals when planning for retirement is how much capital is required to retire financially independent. Variables such as life expectancy, medical condition, levels of debt, as well as personal preferences and expectations make it difficult to quantify the amount of capital required at retirement.
However, a broad measure known as the replacement ratio offers guidance to determine the amount of capital required. This measure indicates how the monthly income earned from your retirement income will replace your final monthly salary amount.
A general rule
A general rule applied in the retirement industry suggests that a replacement ratio between 70% and 80% should be sufficient to maintain your lifestyle at retirement. This means that every R1,000 earned as a final salary shoud be replaced by R700 to R800 of income from your retirement capital.
Depending on the assumptions made relating to life expectancy, investment returns, inflation and the required growth in income, the capital lump sum needed at retirement can be calculated for a specific replacement ratio. Financial planning tools provide a means to determine the capital amount required at retirement.
For example, if you retire at 65 with an annual income of R500 000 and a need for 80% of the final monthly salary and live another 25 years, you will need approximately R8 million in capital at retirement.
The one variable that is difficult to quantify is the age that you are expected to live to.
Current mortality statistics show that at least one member of a couple who is aged 65 has:
a 99% likelihood of living to age 70;
a 96% likelihood of reaching 75;
an 88% likelihood of reaching 80, and
a 52% likelihood of reaching 90.
Therefore, the greater your life expectancy, the greater the amount of capital you will require at retirement.
In order to cover any shortfall in retirement capital, you will be left with these options:
Save for longer before retirement
Work longer than originally planned
Adjust your lifestyle
Choose to take more investment risk for greater returns
A combination of these