WHY YOU NEED TO SAVE FOR RETIREMENT
According to National Treasury only 6% of the population will have accumulated enough money to retire comfortably, without having to sacrifice/ reduce their standard of living. This very low percentage is under more pressure as many South Africans are reluctant to contribute to retirement savings as they fear that the government is trying to adapt legislation that could allow them to regulate what they can invest in. Whilst we personally don’t believe all the negative noise, we feel that saving for your retirement is a necessity and one of the most critical things to get right. In this month’s Financial View we look at “why” we need to save for retirement. As to the “how” there are a few different ways of building sufficient capital.
Why we need to save for retirement
A recent article by another well-known Financial Advisor put it very well. All of us will only ever earn a finite amount of income over our lifetimes. For the vast majority of us this will predominantly come from a salary we earn while we are employed. The problem is that we will invariably live far longer than what our career lasts. This period after employment is often referred to as the golden years but for 94% of South Africans this will be anything but “Golden” and rather it promises to be a struggle through retirement.
When we retire our costs don’t dry up but our income from employment does. We thus need to replace our income from employment with income from another source. To create this additional source of income we need to buy assets that will generate a return in the future. Just like a squirrel preparing for a lean winter we need to bury (just a metaphor, please don’t start digging up your backyard) away our excess funds that we don’t need now, to be able to access in our lean winter years of retirement.
What happens if you retire without sufficient income?
The consequences of not having enough for retirement are pretty dire. We feel that there are only three options available to you if you aren’t “well-off enough” to retire.
1. Continue working – retire later at an older age
2. Rely on financial support from a government grant
3. Rely on your family for financial support
To continue working beyond the normal age of retirement is not always a guaranteed option. Your employer has the option to ask you to pack your desk when you hit retirement age with no recourse back to the employer. That being said people are living longer these days and a good percentage of us will hit our mid 60s still very active and able to continue working.
The government grant is not also a viable option. The government will support you if you fail a financial means test but they will pay you a meagre R1 890p/m. It is a liveable wage given that it is above the breadline but it will not allow anyone any financial freedom besides the ability to purchase some food staples. It will not cover issues around shelter and medical costs. Many of us currently spend more just on our telecoms than the current older person’s grant.
So, the only viable option is to rely on your family to support you. Will they be in a position to do so though, especially if they are having to support their own children at the same time?
How do we get to that point where we can retire comfortably?
Logic tells us that we need to put a portion of our salary (while we are earning) each month to have that asset base for retirement. Industry theory states that this amount should be at least 10% of salary however the exact amount varies from person to person. Successful countries like the UK and Australia have a forced form of retirement savings. While this is not the case locally here are some factors to consider:
• How long you are going to live in retirement (does your family have a history of living to old age)
• How long you can save for retirement (the earlier you start, the better)
• And what you want to do in retirement (the more you wish to spend, the more you need to save).
Personally, I’ve always dreamed of sailing the Caribbean when I am retired – I need to save a huge amount and have had to put away a lot more than the bare basic minimum of 10% just to give my dream a chance.
At Magwitch we always harp on about the power of compounding and that is the real magic of how the successful person can afford retirement. It’s important to reiterate that anyone we see who has saved consistently each month over a long period usually have accumulated sufficient assets to retire comfortably. It is those who procrastinate, start late, don’t contribute enough or access their funds before retirement are the ones that always struggle.
But back to compounding and when you hear the saying “the money working for itself” that is effectively the power of compounding. When investment returns constitute the bulk of your investment balance you have cracked it.
We often use this example, but it bears repeating.
We have 3 students A, B, and C. All 3 are 20 years old and want to retire at the age of 60.
A – starts saving R500pm at the age of 20, they stop saving at the age of 30 but leave their capital in the investment. A only contributed for a ten-year period.
B – starts a bit later at the age of 30 and they invest R500pm until the age of 60. B contributed for a thirty-year period.
C – only starts at the age of 40, but to make up they invest R3 000pm until the age of 60. C contributed for a twenty-year period.
Over the period till the age of 60, A has invested R60 000, B has invested R180 000, and C has invested R720 000.
The total balance of the three investors at age 60 will be:
A will have R5 966 846 (invested R60 000)
B will have R2 210 323 (invested R180 000)
C will have R3 436 557 (invested R720 000)
The simple fact is that because of the incredible power of compound interest, B and C simply could not catch up. While this is a very simple illustration it shows a very powerful force at play. Naturally in the real world there will be inflation and returns aren’t smooth, but this concept holds true under most scenarios.
The investment vehicles available to save for retirement
We won’t seek to provide all the answers to this question as ultimately there are a number of ways you can build an asset base. We favour the existing retirement structures within South Africa such as pension funds, provident funds or retirement annuities (which are applicable if you don’t have access to the first two). The reason we like them is that they are the most tax efficient way of saving for your retirement – and we just don’t like paying tax. We try structure our tax affairs to pay as little as legally possible because we really don’t see a lot back from the government on the taxes we pay. The largest components of the fiscus’s expense items are salaries, grants and interest – of which we receive nothing.
We know some people are concerned that the government is going to “try access our retirement savings”. Whilst there may be some in the government that would love gain access to your money, we cannot believe that they would be so stupid to allow this to happen. The reality is that the government is trying to encourage people to save, so that they don’t have to look after them in their old age. National Treasury and SARS are well aware of just how gatvol the taxpayer is and any moves to impact their financial rights could result in a large portion of the taxpayer base leaving our country.
There are many different ways to skin a cat and people can save for retirement by building capital in other ways. These include the creation of a property portfolio, or a portfolio of shares and commodities. You can contribute to your retirement savings, allocate a portion of this to your Tax Free Savings account, make use of endowments or invest in Unit Trusts. Often, in addition to accumulated savings, the family home is one of your biggest assets. There are really so many different options. The most important thing to always remember is the “why” are we saving for retirement. Time is on your side, the longer you do it the easier it is to achieve your goals.
Start at an early stage, do it for as long as possible, make sure you are putting enough aside, invest in the correct asset classes, have exposure to both local and global assets, and finally don’t touch your savings – leave them to grow and you will have gone a long way to making the most of and enjoying your Golden Years.
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