/ 21 April 2011

Rules for a comfortable retirement

Rules For A Comfortable Retirement

In a recent research study, financial services organisation, Alexander Forbes concluded that only 12% of 700 000 retirement fund members will retire “reasonably” financially secure.

“The Alexander Forbes Member Watch series showed that the average outcome achieved by individuals retiring from funds was a net replacement ratio (the ratio of pension income to final salary) of around 30%,” says Michael Prinsloo, Head: Employee Benefit Consulting Strategy at Alexander Forbes. And only one in 10 retirees had a replacement ratio better than 75%, the number largely touted by industry as acceptable. Savers seem aware of the difficulties.

“A mere 40% of pensioners believe they have saved enough for retirement,” says Danie van Zyl, Head of Guaranteed Investments at Sanlam Employee Benefits. “This contrasts with the 50% of active retirement fund members who believe they are on track to meet their financial goals.” He was quoting statistics from the 2010 Sanlam Benchmark Survey, widely regarded as the most comprehensive survey of South Africa’s retirement fund space.

Andrew Davison, Head of Institutional Asset Consulting at acsis, says that the statistics offered by the industry are rough estimates and are seldom conclusive. “The difficulty is deciding what ‘comfortable’ means and then actually measuring the individual retirement experiences of a representative sample,” he says.

Although terms such as “reasonable” and “comfortable” remain open for interpretation the “ball park” figures offered up by the industry remain frightening. Semantics aside, the average saver needs to know the answer to the “How much is enough?” question “The rule of thumb for retiring independently is that you will need a capital sum of 15 to 20 times your final annual pre-tax income,” says Jeanette Marais, Director of Distribution and Client Services at Allan Gray. This capital amount should be sufficient to secure a net replacement ratio of 70% at age 65.”

The accepted path to this savings goal is to put away 15% of your gross income over your entire working lifetime (at least 35 years). “Savers tend to forget that the retirement funding deductions on their monthly payslips include life and disability cover while, the total employer and employee contribution during 2010 averaged out to 11.7% — way short of the recommended contribution,” says Van Zyl.

Although there is confusion around what constitutes an adequate retirement provision, industry experts speak with one voice on how to go about saving. They consistently offer three rules for a successful retirement. Rule one and two are entirely in the savers’ hands. But savers rely on the variable market returns secured by financial services professionals and savings and insurance product providers for the third.

The first rule is to begin saving as early as possible, starting with a portion of your first paycheck. “It takes at least 35 years of consistent saving to save for retirement and even then, if your investments haven’t performed well, or inflation has sky-rocketed, you could still be short,” says Marais. All else being equal, a saver who starts saving at age 35 will have 40% less capital on retirement than one who starts at age 25.

The second rule is to preserve funds whenever you change jobs. Marais explains: “Investors commonly decide to cash in their retirement savings, if their fund rules allow, when they have been retrenched or are changing jobs, adopting the short-sighted premise that they still have time to make up for the ‘lost’ years.”

The reality is investors seldom recover these funds and end up facing a serious retirement funding shortfall years later. “The failure to preserve retirement savings is one of the major reasons our retirement statistics are so appalling,” says Van Zyl. And Prinsloo agrees: “One of the main contributors to the poor savings performance identified in our member surveys is the lack of preservation of pension benefits.”

The third and final rule for a successful retirement is to ensure your retirement funds work for you. “You should target a return in excess of inflation, preferably a 4-5% real return over the bulk of your working career,” says Davison. It is common practice to adopt a more conservative strategy as you near retirement — though some exposure to growth assets (such as equities) is still advocated.

The retirement fund industry has typically achieved the returns Davison refers to, with pension funds returning around 5% per annum above inflation over the long term. No matter how dedicated a saver you are — and regardless of your employer-linked pension arrangement — it is wise to make additional provisions for your retirement.

Craig Aitchison, Managing Director of OMAC Actuaries and Consultants, suggests that investors find out what replacement ratio their retirement fund is targeting, and that they pay close attention to their retirement fund performance. “Given that many members are not managing to preserve their retirement savings, a good rule is to invest as much extra as you can,” he says. A sensible option is to make two or three non-pension fund investments with the aim of diversifying your risk.

“Diversifying your investments across other investment options means not having all eggs in one basket, but you must consider the long-term return, tax advantages and risk nature of each investement,” agrees Van Zyl.

“One of the key challenges when saving independently for retirement is to resist the temptation to access the money,” says Davison. “To this end retirement annuities and preservation funds make good retirement-dedicated investments.”

Disciplined savers can also make use of unit trusts to supplement their retirement savings. “A discretionary portfolio of unit trusts enables an investor to be more aggressive, by holding higher percentages in equities or offshore investments, than is possible with retirement funds,” says Marais. Other savings vehicles have high degrees of risk attached.

A common practice is for entrepreneurs or self-employed individuals to rely on “selling the business” to see them through retirement. Property can also be a good investment provided you clearly designate it as retirement savings. “There are some pitfalls to property investments,” warns Davison.

“Be careful not to invest too heavily in a single geographic area (such as a block of flats in Johannesburg) and pay close attention to the management inputs required. Managing a huge property portfolio is easy at age 65, but might be daunting 15 years later.”