This article was first published in the fourth-quarter 2014 edition of Personal Finance magazine.
Increasing longevity means your retirement years could make up a third of your life. So it has never been more important not to stick your head in the sand when it comes to retirement funding, because you think saving more is out of the question.
Ideally, a good financial planner should help you to determine the income you need in retirement and what you need to do to achieve your goal. But if you don’t have an adviser, there’s no excuse for remaining blissfully unaware. The sooner you get to grips with how far off a comfortable retirement you are, the greater the impact you – and compound interest – will have on your future resources.
Retirement-funding calculators remain online rather than in the app stores, and, unfortunately, most may leave you, at best, with unanswered questions, and, at worst, bewildered. The problem is that the calculations are based on information and assumptions that most of us neither have nor know how to make.
If you are a salaried employee with an employer who contributes to a retirement fund on your behalf, your first difficulty could be working out how much you are saving. You need to know what your employer is contributing and how much of that contribution actually goes towards retirement funding, because a large chunk of it may go towards group life and disability cover.
You may also need to know what percentage of your total income you and your employer are contributing to your fund. Retirement fund contributions are often based on an income that excludes certain extras, such as a car allowance or your bonus.
Then there are the assumptions you need to make. Typically, you need to state what you expect the average inflation rate to be while you are saving and the percentage return you expect from your savings.
Steven Nathan, the chief executive of low-cost passive retirement product provider 10X, says the inflation issue is a bit of red herring. It affects your returns and the income you need in retirement in the same proportion, and you should be asked only for the real (after-inflation) return.
Recently, 10X launched both a retirement calculator and an online retirement-planning guide or course. You can access these from www.10X.co.za by following the “Retirement calculator” link in the “Education” menu, or the “Retirement guide” highlighted on the home page.
The guide, complete with videos and links to articles, has been developed in partnership with Cognician, and 10X says the aim is to take you on an interactive journey that will empower you to develop a realistic retirement plan.
The key lessons of the guide are that, in order to meet your retirement goals, you need to:
* Save at least 15 percent of your salary (before tax) every month;
* Save for at least 40 years (your entire working life);
* Earn an after-inflation return of at least five percent a year over time; and
* Pay one percent (or less) in fees on your savings.
The 10X calculator is prepopulated with your information if you are a 10X retirement annuity (RA) or umbrella fund member, and 10X also has an app for its members. If you are not a 10X member, you can input your pre-tax income and the rand amount you are saving for retirement (don’t forget to include employer contributions if your employer makes these), and the calculator will determine what percentage of your income you are saving.
Next, you can enter the rand amount of your current savings, your current age and the age at which you want to retire. The calculator asks you to state what fee you are paying to a financial adviser, which is relevant for contributions to an RA.
Since 10X’s aim is to get you interested in its RA, the calculator will determine for you the income you will receive in retirement, or the lump sum you will have at retirement, for two options: first, if you save using a 10X RA (with total annual fees of 0.9 percent), or, second, if you use an industry RA with assumed total fees of 2.85 percent (excluding adviser costs).
This is where the calculator becomes less useful: it does not cater for lower fees. If the fee on your fund is between that of 10X’s fund and an industry fund, Nathan suggests you use 10X’s fee and add the difference to the adviser fee.
As a member of an employer fund, you may not even know what fees you are paying and you probably have no choice but to belong to it. When it comes to the latter, you can switch from one RA to another, but you need to watch out for possible penalties and weigh up this cost against the benefits of switching.
The 10X calculator’s results are returned for an assumed income in retirement, or a pension, equal to 60 percent of your current income (which is known as the replacement ratio). There is much debate about whether the replacement ratio of 75 percent targeted by many employer-sponsored retirement funds is sufficient, so you may want to increase the ratio. You can also adjust other assumptions or factors used in the calculation – for example, you can see the impact a later retirement date, or saving more each month, would have on your retirement income.
10X says its calculation of the monthly income you will receive in retirement assumes that you will use all of your savings to buy an inflation-linked guaranteed annuity – that is, a guaranteed pension that increases annually with inflation, but has no residual capital to leave to your heirs when you die.
If you buy a guaranteed annuity, you don’t need to worry about how long you will live in retirement – the life assurer takes that risk, so the 10X calculator does not ask you to make an assumption about how long you will need an income in retirement.
Nathan says 10X plans to launch a living annuity calculator soon.
The 10X calculator also doesn’t ask you to assume an inflation rate, because it uses real returns in line with those you would earn in the 10X default RA portfolio, with 75 percent exposed to equities until five years before retirement, when your savings would be moved into slightly more conservative investments. You can adjust the calculator to see what effect a lower exposure to equities would have on your income in retirement.
The calculator provides the results for “average” returns, but you can also see what effect earning “poor” returns would have on your retirement income. 10X has used after-inflation data from 1900 to 2013 to determine the average returns over numerous 40-year periods – for example, the average real return for a multi-asset high-equity fund was 6.6 percent. 10X says, historically, over a 40-year savings period, the returns in just one in four cases have been worse than those predicted for “poor” returns, and in three in four cases, they have been better.
Nathan says a good average real return to use for a low-equity and a medium-equity multi-asset fund would be 2.9 percent and 4.9 percent respectively.
There are other online retirement-funding calculators, but they all require you to make assumptions about investment growth, expected inflation rates and how long you will live in retirement. None of them states the assumptions used to calculate the income in retirement.
Momentum (www.momentum.co.za) has a retirement calculator as part of its My Financial Wellness section, which allows you to calculate the contributions required for a particular income in retirement, or the income your current savings and contributions will generate. This calculator also has sliders you can use to adjust factors, such as your retirement age and your contributions.
Liberty’s calculator (www.liberty.co.za/ Pages/retirement-calculator.aspx) works out how much you need to save to meet your income expectations in retirement, either as a single lump sum or as monthly savings with or without inflation-linked increases. It provides a life-expectancy table, which is useful, but remember that these figures are averages and you could live longer than the average. It also asks you what income you can expect from existing retirement policies – a difficult question to answer if you know only the lump sum you have saved to date.
Old Mutual has a similar retirement funding calculator at www.oldmutual.co.za/personal/retirement-planning/retirement-calculator.aspx. This one shows you the income you can expect from current savings, and if it falls short of your needs, suggests some corrective action you can take, such as increasing the monthly contributions and/or working for longer.
Sanlam’s calculator (http://www.sanlam.co.za/wps/wcm/connect/sanlam_en/sanlam/tools/retirement) has an interesting feature that allows you to provide for a lump sum required in retirement – for example, for a vehicle or an overseas holiday.
A key message of the 2014 survey of retirement and other benefits by Alexander Forbes, the Benefits Barometer, is that retirement fund members need to be aware of their financial progress, instead of sleepwalking to retirement. To this end, the retirement administrator argues for your pension benefit statement to give you information about what your savings and benefits mean in terms of the income you could receive if you were disabled, or your beneficiaries would receive if you died before retirement.
Taking that idea a step further, one day there will be an internet or smartphone app that will give you this kind of information for all your retirement savings and your life and disability cover. Checking your progress regularly would make you much more alert to the realities of retirement saving and hopefully spur you to action, sooner rather than later.