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Monday, 27 August 2012

How much do I need to save for retirement?

You need R6m to earn a pension of R15 000 a month

How likely is it that you will have R6 million in savings and investments if you retire at age 60? That is the amount you will need to ensure you will have at least R15 000 a month (before tax) on which to live without eating into your capital amount. Most South Africans will not have a financially secure retirement, because they do not save enough.

The proof is in the fact that South Africa’s household savings rate (expressed as a percentage of gross domestic product) was a dismal 1.5 percent last year. Unfortunately,  human nature is to focus on the now, which, for most people, means surviving financially from month to month. The majority of households do not have an emergency lump sum saved, and providing for retirement is often not even on the agenda.

Saving money is an unattainable luxury for many South Africans who live on the breadline. In retirement, these people are forced to survive on the social old-age grant of R1 200 a month.  That R1 200 a month is too little for most employed people to maintain their standard of living. This means you must make saving for your retirement your number one financial planning priority – not new cars, bigger houses and a wardrobe filled with the latest fashions.

A good rule of thumb is that 12 times (15 times if you support your spouse) your annual salary is likely to buy you a financially comfortable retirement, assuming that you are debt- free by the time you retire. For a more accurate figure, you must have your financial needs assessed by a qualified financial adviser. If you currently earn R1 million a year, you will need to save about R12 million by the time you retire. With an annual real return of three percent, you are likely to receive a pension of R30 000 a month (pre-tax), increasing in line with inflation. If you earn R120 000 a year, you will need to put away close to R1.5 million by the time you retire to give you a pension of at least R3 750 a month.

The problem of South Africa’s poor savings rate is made worse by the merging trend of people living longer. To survive financially, most South Africans will have to work to age 65 or beyond, while many pensioners will have to find ways to supplement their income to avoid drawing on their capital. The key to accumulating enough money for a financially comfortable retirement is to start contributing at an early age. This is not only because you make more contributions, but also because you harness the power of compound interest. The sooner you start contributing, the sooner your contributions earn interest and the sooner interest on that interest is earned. Assume that once retired you would like to receive a monthly pension equal to 90 percent of your final salary. To achieve this, you need to contribute 15 percent of your income from age 25. 

However, if you start contributing at age 35, the rate jumps to 25 percent. If you leave it to age 45, the rate is 47 percent. For every 10 years you delay saving for your retirement, the required contribution rate as a percentage of your salary doubles. Even if you cannot save at the required rate now, at least make a commitment to whittle down your debt faster. Once you have cleared your debt, take the money you used to repay your debt and start saving it.

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