Traditionally, people work on the idea of saving a certain amount – such as 15 times their annual salary – to cover their needs in retirement. But these plans may be upset by factors that cannot be built into typical retirement savings calculations.
According to an article by Laura du Preez in Personal Finance (6 June 2015), targeting a particular lump sum with the view to it sustaining your desired income in retirement may be a bad idea, especially if you assume that you will continue to enjoy high real (after-inflation) market returns indefinitely.
While your initial planning takes into account the income you will need in retirement, Marc Thomas (business development manager at Grindrod Asset Management) says that thereafter, you often receive updates only about the lump sum and not about the income it will generate.
He says the value of measuring retirement savings in terms of the income they can generate is starting to be recognised internationally, but most local asset managers have yet to start thinking in these terms. Most calculations are based on annuity rates (guaranteed, with-profit or even recommended living annuity withdrawal rates) at the time you perform the calculation. Unfortunately, annuity rates, including recommended withdrawals from living annuities, change over time as markets change.
Thomas says the average South African rates for a level annuity have come down from about 14 percent in 2000, to 8.6 percent in 2006, to 7.2 percent today. The rate for an annuity escalating at five percent a year is about 4.2 percent, he says.
Financial adviser Daniel Wessels says you simply do not know what your future returns will be, but you can give yourself a far better chance of a secure retirement if you focus on the things you can control: how long you save for and how much you save.
He suggests that you:
- Extend the period during which you save as far as possible;
- Save as much as you can; and
- If you use an investment-linked living annuity to provide a pension at retirement, limit the annual amount you draw down to between four and five percent of your capital.