The cost of delaying your retirement savings

Putting enough money away for a comfortable retirement is a daunting task and, while we all know that starting early is critical, the numbers are alarming. Statistics from the 2021 10X South African Retirement Reality Report which has just been released are frightening. Around half the people surveyed indicated that they are making no provision for retirement at all, while the other half indicated they have some form of savings plan in place. 74% of survey respondents accept that they will have to supplement their income after retirement – although unemployment statistics make this an unlikely option for many retirees. Interestingly, while 30% of respondents believe that it will take 40 or more years to save for a comfortable retirement, 71% indicated that they have no savings plan at all. And only 8% of respondents – a 2% increase from last year – indicated that they have a proper retirement plan in place.

While government provides us with excellent incentives to invest through approved retirement funds so as to ultimately relieve the financial burden on the state, the uptake remains critically low, and the overwhelming majority of South Africans remain hopelessly underfunded for their retirement years. Many employed South Africans have the option of investing through their employer’s pension or provident funds although, with unemployment being at an all-time high, this option is now available to fewer people than before. Retirement annuities, which are personal retirement funds that are not linked to your employer group, therefore make attractive investment vehicles, particularly for those who are self-employed, whose employer does not provide retirement benefits, or for those who want to supplement their pension or provident fund savings.

Modern retirement annuities are unit trust-based, fully transparent and provide investors with complete flexibility when it comes to choosing an investment strategy, albeit within the ambit of Regulation 28 of the Pension Funds Act. As with all approved retirement funds, investors can save up to 27.5% of their taxable earnings into an approved retirement fund on a tax-deductible basis, up to the annual maximum of R350 000. Besides for the tax benefits of investing with pre-tax money, investors enjoy additional benefits in that no CGT, dividends withholding tax or income tax on any growth earned within these funds, meaning that investors benefit from the compounded tax benefits over the long-term. However, to benefit fully from such structures, it is important to start early, consistently invest enough for your goals, invest appropriately and avoid dipping into your retirement savings. Simply put, the best time to start saving is right now – and if you’re still waiting to save, consider the following scenarios which demonstrate the cost of delaying your investment journey.

In developing these investment scenarios, we have used the following assumptions:

  • Siya is currently aged 25 and is formally employed earning R35 000 per month.
  • He would like to plan for a comfortable retirement at age 65, and would like to draw a post-retirement income of R25 000 per month, which is approximately 70% of his pre-retirement income in real terms.
  • His retirement income will increase annually at a rate of 5%.
  • As he is relatively young, he would like to assume a life expectancy of age 100.
  • Given his investment horizon, Siya knows he can invest more aggressively and, as such, would like to assume that his investments achieve returns of inflation plus 4.5% per year during the accumulation phase.
  • At retirement, he will move his invested capital into an investment which targets annual returns of inflation plus 4%.
  • Any investment premiums will increase annually at a rate of 5%.

Scenario 1: Investing from age 25

If Siya begins investing today with his first pay cheque, he will need to invest an amount of R4 500 per month towards his retirement, which is approximately 13% of his pre-tax income.

Scenario 2: Investing from age 35

If Siya delays starting his savings until he reaches age 35, he will need to invest an amount of R8 500 per month which translates into 24% of his current income. This means that a 40-year investment horizon reduced by 10 years has the effect of almost doubling the required investment premium to achieve the same outcome

Scenario 3: Investing from age 45

If Siya only starts investing at age 45, he will need to invest an amount of R17 500 per month in order to achieve his retirement goal. This translates into 50% of his current income, although only 27.5% of his contributions will enjoy a tax break.

Scenario 4: Delaying retirement

At age 55, Siya realises that he has left his retirement funding too late and decides to delay retirement until he reaches age 70. In order to achieve his goal, he will need to save an amount of R25 500 per month which, being approximately 73% of his income, is unrealistic. Because he has started his investment journey so late, Siya’s money will only be exposed to the effects of compounding for a period of 15 years, whereas in scenario 1 his capital would be able to compound over a 40-year period.

If nothing else, the Covid-19 pandemic has highlighted the need to prioritise saving and investing, and to ensure that one’s financial plan is able to withstand unexpected, unforeseeable eventualities. On the upside, the 10X report indicates that 33% of respondents – up from 27% from last year – worry about whether they will have enough money to live on in retirement which means more people are taking their retirement funding seriously.

If you haven’t started saving for retirement, keep in mind that all is not lost and there are a number of options available to you. Naturally, delaying the age at which you retire is the most obvious option, although there are risks involved in doing so, particularly when it comes to your health and employability at that stage of life. While you may have every intention of delaying your retirement, keep in mind that many illnesses are a function of old age, and you need to factor in the reality that illness can thwart your plans to keep working. Similarly, while you may have every intention to keep working, old age, illness, or reluctance on the part of your employer may hamper your plans. The second option available is to save more although, with a fixed income and a limited time period in which to achieve your goals, this may be practically impossible.

Another option available is to you is to take on more investment risk although, before doing so, it is important to understand what this means for your investments. With a significantly reduced investment horizon, keep in mind that exposing your capital to greater investment risk means tolerating short-term market volatility which may be difficult to stomach as you draw closer to your retirement date. Finally, a workable option is to reduce your post-retirement budget so that you are aiming for a smaller target.

While neither of these options on their own can be considered a silver bullet, employing a combination of all four options may provide you with a chance of achieving a financially comfortable retirement.

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