Waiting to save: the cost of deferring your retirement plan
It is a daunting task to raise enough cash to help you retire comfortably, and while we all know an early start is crucial, the numbers are alarming. The statistics from the just published 10X South African Retirement Reality Report 2021 are terrifying. Around half of the respondents stated that they did not make any provision for retirement, the other half stated that they had a savings plan. 74% of respondents accept the need to top up their income after retirement – although this is an unlikely option for many retirees, according to unemployment statistics. Interestingly, 30% of respondents said it will take 40 or more years to save for a comfortable retirement, but 71% said they had no savings plan at all. And only 8% of respondents – up 2% year over year – said they had an adequate retirement plan.
While the government offers us excellent incentives to invest through approved pension funds in order to ultimately relieve the state financially, the drawdown remains critically low and the vast majority of South Africans remain hopelessly underfunded for their retirement years.
Many working South Africans have the option to invest through their employer’s pension or retirement funds, although unemployment is at an all-time high, but fewer people now than before. Old-age pensions, i.e. personal pension funds that are not tied to your employer group, are therefore attractive investment instruments, especially for the self-employed whose employer does not provide retirement benefits, or for those who want to top up their pension or save on the pension fund.
Modern old-age pensions are unit-linked, completely transparent and offer the investor full flexibility in choosing the investment strategy, but within the framework of Ordinance 28 of the Pension Fund Act. As with all approved pension funds, investors can pay up to 27.5% of their taxable income tax-deductible into an approved pension fund, up to an annual maximum of R350,000. In addition to the tax advantages of an investment with pre-tax money, investors enjoy additional advantages, as no CGT, dividend withholding tax or income tax on the growth achieved within these funds, so that investors benefit from the cumulative tax advantages over the long term. However, in order to fully benefit from such structures, it is important to start early, to invest consistently enough for your goals, to invest appropriately and not to dive into retirement planning. Put simply, the best time to start saving is now – and if you’re still waiting to save, consider the following scenarios that illustrate the cost of delaying your investment journey.
When developing these investment scenarios, we made the following assumptions:
- Siya is currently 25 years old and officially works on a monthly income of R35,000.
- He would like to plan a comfortable retirement at the age of 65 and would like to receive an income of 25,000 Rand per month, which corresponds in real terms to about 70% of his early retirement income.
- His retirement income will increase by 5% annually.
- Since he is relatively young, he would like to assume a life expectancy of 100 years.
- Due to his investment horizon, Siya knows that he can invest more aggressively and would therefore like to assume that his investments will generate an inflationary return of plus 4.5% per year during the accumulation phase.
- In retirement, he will invest his invested capital in an investment that aims for an annual inflation rate of plus 4%.
- Any investment premiums increase annually by 5%.
Scenario 1: invest from 25
If Siya starts investing with his first paycheck today, he will have to invest an amount of R4,500 per month for his retirement, which is about 13% of his pre-tax income.
Scenario 2: invest from 35
If Siya defers starting his savings until the age of 35, he will have to invest an amount of R8 500 per month which is 24% of his current income. This means that a 40 year investment horizon shortened by 10 years almost doubles the investment premium required to achieve the same result
Scenario 3: invest from 45
If Siya does not start investing until the age of 45, he will need to invest an amount of R17,500 per month to meet his retirement goal. This corresponds to 50% of his current income, although only 27.5% of his contributions are tax-privileged.
Scenario 4: Delaying Retirement
At the age of 55, Siya realizes that he ended his retirement plan too late and decides to defer retirement until the age of 70. To achieve his goal he has to save an amount of R25,500 per month, which is around 73. equivalent to% of his income is unrealistic. Since he started his investment journey so late, Siya’s money will only be exposed to the effects of compounding for a period of 15 years, while in Scenario 1 his capital could be compounded over a period of 40 years.
Last but not least, the Covid-19 pandemic has highlighted the need to prioritize saving and investing and to ensure that one’s financial plan can withstand unexpected, unforeseeable events. On the flip side, the 10X report shows that 33% of respondents – up from 27% year over year – are concerned about whether they will have enough money to live on when they retire, which means more people are taking their retirement plans seriously.
If you have not yet started saving for retirement, remember that all is not lost and there are a number of options available to you. Of course, shifting the retirement age is the most obvious option, although it does come with risks, especially for your health and employability at this stage of life. Even if you intend to postpone your retirement, keep in mind that many illnesses are a function of age and you need to consider the fact that illness can thwart your plans to continue working. Even if you intend to continue working, age, illness, or reluctance on the part of your employer can hamper your plans. The second option is to save more, although it is virtually impossible to do so with a steady income and limited amount of time to complete your goals.
Another option is to take on higher investment risk, although it is important to understand beforehand what this means for your investments. With a significantly shortened investment horizon, keep in mind that you will need to expose your capital to greater investment risk to tolerate the short-term market volatility that can be difficult to endure as you near your retirement date. Finally, a viable option is to reduce your budget after retirement so that you can aim for a smaller goal.
While none of these options can be seen as a panacea on their own, combining all four options can offer you the chance for a financially comfortable retirement.