How long is a piece of string?

by Dominic Ilett

When planning for retirement, it is crucial that clients know how much capital they require in order to provide for their financial needs in their golden years. To solve this conundrum, a number of variables must be considered, such as estimating what their expenses are likely to be and how this could increase. Thought should be given to their life expectancy post-retirement. Importantly, careful consideration should be given to how best to invest their hard-earned savings and finally, what tax they will need to pay.

How much will I need and by how much will it increase?

Clients should estimate their current and future monthly expenses. This could include items such as the repayment and settlement of any debt (bond and vehicle instalments), the payment of education bills if they still have children studying, medical costs and the occasional vacation, as well as their daily subsistence costs. Although the reported consumer price inflation in May 2014 was 6.6%, most people experience a higher price inflation when purchasing their own basket of goods and services especially when electricity price hikes, rising fuel costs, rates and taxes and other administered prices are considered. Hence, any reckoning of future expenses must take inflation into account, for example the price of a loaf of bread today at R8 will increase over 20 years at 7% inflation to R32.10.

What is my life expectancy?

According to Statistics SA, in 2003 the life expectancy at birth of a male was 49.5 years and a female 54.4 years. Ten years later in 2013, the life expectancy of a male increased to 57.7 years and 61.4 years for a female. Improved nutrition, healthier lifestyles and medical advancements are some of the factors that have contributed to people living longer. While this is exciting, it is also a worry particularly because many people have not saved enough to fund a longer post-retirement livelihood. People also tend to retire at younger ages and therefore start to live off their retirement savings earlier.

How do I save for my nest egg?

Any capital accumulated over your working life – whether through a retirement fund, retirement annuity or through discretionary savings – will form the basis to sustain your current and future financial requirements. Determining a suitable investment policy that will provide a good return on your capital, without taking undue risk, and that will meet your monthly financial needs for as long as possible is critical. So often people go on retirement with insufficient capital saved. Through desperation, they are easily tempted to invest in get-rich-quick schemes to bridge the gap. These too-good-to-be-true ideas are just that and should be avoided. Compound interest is an investor’s best friend and therefore the earlier you start saving for retirement, the better.

But what about SARS?

The impact of tax payable on the income earned from saving should not be overlooked. Through efficient tax planning your capital could last longer. Also take note that retirement fund income and redemptions from discretionary savings are taxed differently and an experienced advisor can significantly reduce your tax liability of you’re a pensioner.

The following example explains the effect these variables can have on the period that the income will last. By saving R500 000 more for retirement, achieving a higher rate of return, lowering the tax rate and keeping expense increases modest, Mr Smith will be able to live off his capital for 12 years longer.

 

Mr Smith’s piece of string

Capital saved

1,500,000

2,000,000

Monthly income

10,000

10,000

Rate of return on his investment

10%

15%

Tax rate

30%

20%

Assumed increase in income per month

13%

10%

Period that income will last

10 years

22 years

 

But that’s not all!

Everyone’s circumstances are unique and thorough long-term planning and saving should be started as soon as possible. It is vital to understand these important levers and their effect on post-retirement financial wellbeing. Most important, pensioners need continued advice after retirement and regular review and revision of their income vs. their capital to ensure that ideally their capital outlives them.

By autusco

Wednesday, October 1st, 2014

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