Tumi is in a very rare situation. Unlike most companies, her employer does not make any contributions from their side. She is the only one contributing 7,5% of her salary towards her pension fund, which is not sufficient. She will definitely face a shortfall of funds if she wants to retire at 60 and does not increase her retirement savings.
Her first steps toward retirement planning are to ask herself the following questions:
- At what age am I planning to retire?
- How much money will I need to retire comfortably at that age?
- Where am I now in terms of my savings, and how much more do I need to make up for any shortfall?
- What other options of retirement savings are available to me, besides a pension fund?
- How many years after retirement am I prepared to plan for? In other words, is planning for 20 years of retirement sufficient?
Let us suppose that Tumi is planning to retire when she is 60 years old and wants to secure herself financially until she reaches the age of 80. She would need to establish what percentage of her salary would suffice for her required pension. Certain expenses could also fall away during retirement years, such as vehicle finance, a mortgage loan and education fees. Tumi will also pay less tax as a pensioner, after she turns 65.
Let’s say she needs an income of 65% of her salary to be able to retire comfortably, and let’s base the calculations on an inflation rate of 7% per annum, with a current salary of R18Â 000 a month, salary increases at 8% a year and a net investment yield of 10% per annum on her savings before retirement, as well as the capital after retirement.
This calculation shows that a capital amount of about R11million will be needed at the retirement age of 60 to provide Tumi with her required income, increasing at the rate of inflation for a period of 20 years after retirement.
However, with the current scenario, Tumi’s pension fund will only provide 36% of her required capital for retirement. Overall, Tumi would need to make up a shortfall of about R7million to be able to retire securely and comfortably. In other words, she would need to save R2Â 400 or more a month, with an escalation of about 10% per annum for the next 25 years, to fund the shortfall.
This clearly illustrates that a pension fund contribution of only 7,5% of her salary is far too low. She and her employer should, in total, contribute at least 15% of her salary if she wants to retire adequately at 65.If Tumi wants to retire earlier, the contributions should be more.
Even if she decides to increase her pension fund contributions to 10% by means of her recent salary increase, she would still need to save an additional R2Â 000 or more a month (escalating at 10% per annum) to make up a shortfall of about R6,2million (assuming she wants to retire at 60).
Tumi’s situation clearly demonstrates that one cannot depend solely on one’s pension fund to retire comfortably. There are many other options to make up for these kinds of shortfalls.
There are other vehicles for saving that Tumi could purchase for retirement, such as:
- Retirement annuities (a retirement fund product that provides you with lifelong income payments during your retirement years).
- Unit Trusts (a collective investment that invests in a range of assets, for example, equities, fixed interest and cash. A unit trust can be either a general fund or a more specialist fund investing in a particular type of asset).
- Other investment options (for example, property investment, shares investment, et cetera).
The choice of a saving option is completely dependent on Tumi’s individual needs — she could either invest in one vehicle or spread her savings into more than one. Although Tumi must ensure financial independence, she and her husband should plan and work towards a combined goal for their retirement and not in isolation.
Tumi’s decision
Tumi has decided to allocate her salary increase to improving her pension provision. In June, she will have settled her store card debt, providing her with an additional R586 to invest for her retirement. Although there will still be a shortfall, Tumi will use future bonuses to add to her retirement fund.