Planning an early retirement is a goal that many ambitiously set for themselves, but it takes an enormous amount of discipline, planning and sacrifice to make it happen. It also means you’ll need to start dreaming and planning early on in your career to ensure that your goals can be met. While you are earning, maximising tax deductions and attacking debt will be priorities as you move to build assets faster than the norm. But the dream of an early retirement may not be as simple as it sounds. Here’s what you’ll need to take into account.
Your vision of an early retirement
Understanding what retirement looks like for you is the first step in the process, as this will form the platform on which your retirement plan is built. Start by asking yourself why you want to retire and at what age. Do you want to continue generating an income in retirement? Do you intend downsizing your home? Are you retiring to escape a job that you hate? Does your spouse want to retire at the same time? What does financial freedom mean to you? What is your number? A successful early retirement involves making and stress-testing a number of assumptions, and then building a plan that is flexible enough to withstand multiple decades.
Being one of the most important assumptions to get right, you will need to give careful consideration to your life expectancy and that of your spouse. If you plan to retire at age 55, you could well have 40 years’ worth of living expenses to plan for – that’s 480 withdrawals from your accumulated capital. Importantly, keep in mind that your monthly living expenses do not necessarily reduce after retirement and, in fact, as you age you can expect your medical and associated healthcare costs to escalate.
You will need to make some important decisions around your retirement funding quite early on, and the timing of many of these decisions can be pivotal to your future planning. For instance, you will need to decide when best to retire from your retirement annuity, which is permitted any time from age 55 onward. Retiring as early as possible will allow you to make a lump sum withdrawal from the fund (assuming no previous withdrawals have been made), and will give you the opportunity to incorporate more offshore exposure through a living annuity structure. From an estate planning perspective, you will also be able to nominate the beneficiaries to your living annuity. On the other hand, remaining invested in your retirement annuity will allow your investment more time to grow before you begin drawing from it. On the downside, Section 37C of the Pension Funds Act means that the distribution of any retirement fund monies will remain at the discretion of the fund trustees, and this could hamper your estate planning strategy. Furthermore, while invested in a retirement fund, your asset allocation is subject to Regulation 28 of the Pension Funds Act which limits your offshore exposure to no more than 30% of the fund. Once you retire from a retirement fund, your investment is no longer governed by the Pensions Fund Act. Another important decision that will need to be made is whether to invest in a living annuity or life annuity, or a combination of both.
Retiring from your retirement funds marks the transition from saving towards retirement to drawing from your capital and pitching your draw down rate at the right level at the outset is critical. The 4% rule, which has its critics, assumes that if you withdraw 4% of your savings annually, adjusted for inflation, you will be able to continue drawing at that level for a period of 30 years. However, an earlier retirement will mean that you need to withdraw significantly less from your living annuity because your capital needs to survive 40 years or more, keeping in mind that the annual minimum drawdown rate is 2.5%. Managing your drawdowns and strategically supplementing your income needs from your discretionary investments in the most tax-efficient manner to ensure that you don’t run out of capital will be a critical component of your planning.
It goes without saying that ensuring you can manage your long-term healthcare expenses will be an important aspect of your plan. Generally speaking, you should base your planning on the assumption that your medical aid and associated healthcare costs will increase annually at a rate of inflation plus 4%. If you enjoy a medical aid subsidy through your employer, you will need to factor this into your planning. Retiring while you are young and healthy may mean that you do not give sufficient thought to your healthcare costs later in life which could involve the need for frail care facilities, home care or assisted living accommodation. Your monthly healthcare costs at age 55 are likely to be very different in real terms than when you are 80, so be sure to build a buffer in your budget.
An early retirement may mean remaining in the family home until you feel the need to downscale at a later stage. A long retirement horizon could also mean that you transition from the family home to a smaller retirement home, and eventually on to a retirement village. Your plan will therefore need to take into account the costs of buying and selling property after retirement, as well as the costs of renovating and/or altering the property. If you are dependent on the equity in your property to help fund your retirement, the timing of the sale of your property will be important to ensure that you don’t find yourself short of cash. With the above in mind, your plan should include assumptions regarding where you intend living in retirement, when you intend to downscale, and how the proceeds of any sale will be invested.
If you’re retired from employment, you will need to consider that your group life and disability cover will fall away so be sure to determine your need for insurance cover before this happens. Assuming that all debt will be settled by the time you retire, you may still require life cover for estate planning purposes so you will need to take into account the costs of securing life cover at age 55.
A retirement at age 55 means that you still have a potentially long-term investment horizon and, as such, you will need to ensure that you are invested appropriately for this time period. You will need to ensure that your investment portfolio is resilient and flexible enough to withstand multiple withdrawals from different income streams with different tax implications over an extended period of time. With a 40+ year time horizon, inflation is your number one enemy as the only growth that really matters is the increasing purchasing power of your money. Inflation can be considered a tax on your assets and if your investment returns don’t outstrip inflation over the long-term you can find yourself financially compromised later on in retirement. Investing for growth while at the same time drawing down from your invested capital may cause anxiety, and you need to take this into account when building an early retirement investment strategy.
Retiring from an occupation that kept your busy 40 to 50 hours a week means that you will need to give careful thought about how to fill your days. Many early retirees attest to feeling bored, depressed and without purpose which, in turn, can affect one’s mental health. Ask yourself: what will my daily diary look like? How will I fill my time? What will I do to remain intellectually stimulated? How will I remain connected and engaged with society? Also important to consider is that eating out, entertainment, travel, clubs and hobbies can add another layer of expenses to your post-retirement budget, so be sure to account for these costs in the planning stage.
You may build your early retirement plan on the assumption that you will have no financial dependants when you retire, but this may not necessarily be the case. What happens if your adult children experience financial hardship such as that brought about by the pandemic and need your help? Do your parents have enough retirement funding in place? What would happen if your aging parents need financial assistance with their retirement? Give careful thought to these eventualities to ensure you are buffered against them.
Lastly, you will need to consider your retirement plan in view of your desire to leave a financial legacy to your loved ones. If you plan to leave assets to your adult children, determine how this maps against your overall plan. How much would you like to leave your adult children and in what structure? Will there be enough in your estate to achieve your estate planning goals? Are your retirement plan and estate plan fully aligned?
An early retirement requires careful planning and consideration as to all eventualities that could occur during an extended retirement phase, and it is always advisable to seek independent retirement planning advice.
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