In pre-retirement years most people see contributions to a pension fund as a ‘grudge purchase’.
They feel they could do more with that money possibly due to the fact that the cost of buying a house, educating children and so on means that there is often too much month left at the end of the money. The problem is worsened by most HR departments in companies. HR should ensure an adviser clearly explains and simplifies the benefits, the importance of saving for retirement as well as the other associated benefits, e.g. risk insurance, etc. Unfortunately HR often is not informed enough to do this.
In fact one very large company had an HR department that simply put their employees into a money market fund as a default portfolio. This literally meant that those paying into this provident fund were not even matching inflation growth on their money.
Some companies do not have retirement funds at all, while others deduct around 12% of the wages, which in most cases is not enough. Add to that the issue of people leaving jobs and cashing in the employer provident funds and you have a recipe for disaster.
Another problem is that retirement communication content is laced with jargon that leaves members, and even Trustees and Management Committees, uninformed and un-involved. Effective member communication requires a significant time investment and a shift in the mind set of employers, retirement fund administrators and/or their employee benefit consultants.
There are many legal requirements in pension fund saving, and most companies cannot be bothered with employee well being despite the ethics committees and high talk. Worsening the problem is the fact that many fund administrators and consultants do the bare minimum by only ensuring they are compliant with the legislation.
time is our friend with retirement planning
The biggest ally we have is the power of compound interest and therefore the impact of delaying our retirement savings can be severe.
The real return is the return on your money after inflation. For example if you safe R 100 on January the first and that money is worth R 113 in December of the same year then you have earned a 13% return. However most of the time the R 100 will not buy you the same amount in December as it would have done in January. This is called the cost of inflation.
In 1972, a Wimpy burger meal cost 47c. How much does that meal cost in 2019? In 2016 it cost R 49.90
You need to save around 17 times your annual salary by retirement in order to get a lasting return of 7%% of income. To give you an idea of what this would require look at this table.
|Age retirement saving starts||Percentage of salary requirement for a fund returning 11%|
Conventional wisdom says if you start retirement savings at 25 years of age, you would then require 15.5% of income saved to reach ¾ or 75% of income on retirement. At 35 years of age this means saving almost 1/3rd while after 40 you would need to save in excess of half of income you earn.
Why do you need so much income after retirement. Well you won’t be earning for a start so you now start living of the income generated by your savings. Put another way, when you earn you live of monthly earnings or income. When you stop work you need to live of the balance sheet or your assets. We have to ensure our assets work for us, so we can use a number of tools for this and we refer to a draw-downs as the income or an amount you get from the lump sum you hopefully have saved. One of the most popular tools, is a living annuity product and a draw-down on the annuity is done for you to have a steady income.
The living annuity
When you retire you invest the lump sum you saved normally in an annuity product. It may be a voluntary product or an annuity bought with a compulsory amount from your pension fund or retirement annuity (RA) fund. There are many different types of annuities available. The living annuity is the only one that gives you an income earned from this money which you can set per annum as you need. The amount you set is called the draw-down rate and is the amount you take out of your retirement savings per year. We express this as a percentage. Currently in terms of the law you can draw between 2.5% to 17.5% of capital once you put your savings or pension or RA fund monies into a living annuity.
Again we are still assuming you get a 5% real return (after inflation and taxes) and will look at a 4% draw-down rate in retirement. 4% is considered an advisable draw-down on any lump sum. However don’t think that you will get the full R 40 000 per annum as income! All investment products have a cost to them. These costs can vary considerably from a platform fee of between 0.5% to 1% and the fund costs themselves, as well as advisor cost. This 4% includes your costs on the draw-down, so if your costs are 1% you get 3% or R 30 000 per annum for every R 1 000 000 (million) you save. If your costs are 2% then you receive R 20 000 per annum. You can increase your draw-down, but 4% normally means the income will last as long as you do, after that the chance of your income lasting gets less and less. We call this an annuity failure – as the annuity ( monthly income) cannot generate the income you need without eroding the capital. We will look at costs in another post.