Retirement planning is complex and multi-faceted, and the strength of any retirement plan rests heavily on the robustness of the underlying assumptions. This means that any assumptions used should be strenuously tested and regularly revisited to ensure that your retirement plan is fit for purpose. When building assumptions into your retirement plan, avoid committing one or more of these deadly sins:
Underestimating your life expectancy
While there’s no way of knowing how long you will live, we do know that humans are living longer than ever before and, as such, it makes sense to build a ‘best case scenario’ into your retirement plan when it comes to longevity. While your health status and/or family genetics may tempt you to take a shorter-term view of your life expectancy, keep in mind that rapid advances in science and medicine may result in you outliving your projections – and your capital. Trying to guess how long you will live is a dangerous game to play when developing your retirement plan, and our advice is to develop a range of retirement scenarios using varying longevity assumptions so that you have a clear view of what each scenario entails. Most retirees fear outliving their invested capital which means that longevity assumptions are critical to your retirement future. With many illnesses being age-related, bear in mind that your healthcare expenses are likely to increase as you age and that medical inflation compounded over time will result in your healthcare costs consuming a greater proportion of your budget in retirement. Further, the need for frail care accommodation or private care later in your retirement years can drive up costs significantly with these costs being closely linked to longevity.
Miscalculating your post-retirement expenses
Keep in mind that the general rule that one needs 70% to 80% of one’s income after retirement is merely a guideline to be used at the outset of one’s planning. Under no circumstances should this be used as a mathematical measure for how much you need post-retirement, so avoid accepting this assumption as appropriate to your circumstances before digger deeper. This general rule assumes that certain fixed costs such as bond and vehicle repayments, life cover, and investment premiums will fall away at retirement and that, as a result, your monthly costs will reduce by around 20% to 30%. However, it’s important to keep in mind that some costs may increase in retirement depending on your circumstances, and these should be carefully assessed when preparing a post-retirement budget. For instance, you may want to increase your budget line items for vacations and travel, medical and healthcare expenditure, and/or entertainment and hobbies, meaning that accurate budgeting specifically in the years leading up to formal retirement is critical.
Not budgeting for your healthcare costs
While it’s common knowledge that medical inflation outstrips consumer inflation year-on-year by around 3% to 4%, these are not the only healthcare costs that should be factored into your post-retirement budget. Depending on your medical aid, you may need to budget for costs such as assistive devices, aids, medication or treatment not covered by your medical aid. According to StatSA, almost 25% of South Africans over the age of 60 use chronic medication, 20% use assistive devices such as spectacles or hearing aids, and 5% use wheelchairs. As such, when budgeting for your post-retirement medical expenses, give careful consideration to your health status, the range of benefits offered by your medical aid, the extent to which your gap cover policy will fund any shortfalls if you were to be hospitalised, to what extent your chronic medicines are covered by your scheme, and the future costs of assistive devices and aids.
Selling your primary residence too late
For many South Africans, the value held in their primary residence is an important part of their retirement plan making the timing of the sale an important factor to get right. As with investment markets, property markets are cyclical in nature and being forced to realise your property during a downswing can adversely affect your retirement funding. Ideally, ensure that your planner prepares a range of investment scenarios for you so that you can understand the real impact that short-selling the asset could have on your planning. Keep in mind also that selling one’s primary home and relocating to new premises is emotionally and physically more taxing as one ages, so avoid making assumptions regarding when to sell your property without taking into account the softer, more personal factors involved.
Not having access to discretionary money
While the tax incentives available for investing in retirement funds are hard to ignore, it’s important to find a balance between compulsory funds and discretionary money in one’s portfolio so as to avoid liquidity problems in retirement. Remember, when retiring from a pension, provident, preservation or retirement annuity fund, it is legislated that you must use at least two-thirds of the funds to purchase an annuity which is designed to provide you with a regular retirement income, while the remaining one-third, which may be subject to tax, can be withdrawn from the fund. As such, careful liquidity planning – particularly in the years leading up to retirement – is critical. The tax benefits of investing in a retirement fund should be carefully assessed against the need to provide for capital outflows such as weddings, travel, vehicles, or large medical expenses in retirement, with tax planning being an essential part of this process.
Investing too conservatively for your time horizon
Understanding your investment horizon in the context of your retirement plan is critical to avoiding the danger of investing too conservatively and losing out on market returns. On retirement, many investors err on the side of taking a more conservative, short-term view of their investments which can be detrimental to their portfolio. A long-term investment horizon is for investments that one expects to hold for ten to twenty years so, if you’re planning to retire at age 65 assuming a life expectancy of age 95, it is realistic that a portion of your investment portfolio should be exposed to growth assets to ensure that your overall portfolio beats inflation over the longer term. While understanding your propensity for investment risk is an important part of the planning process, just as important is assessing the risk you need to take to ensure a comfortable retirement and the returns you need to generate to ensure your invested assets grow in real terms.
Not viewing your investments in the context of your estate plan
The purpose of estate planning is to ensure that your assets are structured in the most appropriate, tax-efficient manner while you are alive, and to ensure that those assets are effectively transferred to the next generation when you die. As a result, it is important that you and your planner take a holistic view of your portfolio to avoid expensive, unintended financial consequences later on. In the absence of an estate plan, your estate could be saddled with unnecessary costs and taxes in the event of your death, leaving your intended heirs with legal complexities, heartache and/or a diminished inheritance. Remember, no single investment can be viewed in isolation and every asset has a role to play in your overall estate plan.
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