How to play retirement catch-up

Delaying saving for retirement is not uncommon. Other life costs seem more important­ – there’s a wedding to pay for, a deposit for a new house to put down, a baby, school fees and that holiday you absolutely must take. And, even for those of us who have been forced to save (thanks to a compulsory pension fund or retirement annuity deductions at work), it might not be enough.

It certainly pays to start saving as early as possible, but if retirement is suddenly closer than you realised and you haven’t saved enough, it’s never too late to start.

Make the most of your time

It’s not only theamountof money saved that counts, but alsowhenwe start saving. The earlier you start, the more affordable the amount of money you need to put away each month will be.

More than half of us only start saving at age 28, instead of when we start working. And there are many people who only start in their thirties, or later, when they hit 40.

The thing is, it’s not just about “catching up’ savings over the last five/10/15 years that you’ve missed. That’s a tall order in itself. It’s about making up the compounded returns you’ve completely lost out on!

Imagine a saver, Xoliswa, who starts saving for retirement at age 25. (Please note that the following calculations illustrate a point about compounding and time, and do not account for inflation-adjusted increases in contributions.)

Saving R5 000 a month, at an average 6% return per year over time, she’ll have more than R7 million by age 60.

Mark starts saving at age 35. He will only have R3.46 million at age 60 ­ less than half what Xoliswa saved.  To get anywhere close to Xoliswa’s amount, he’ll need to save R10 000 a month to reach R6.9 million in his 25-year investment horizon.

Starting even later – at age 45 – and you’re in an even more difficult scenario. Even saving R20 000 a month – four times what Xoliswa started saving at age 25 – won’t even get you to R6 million.

That’s why it’s so important to follow Xoliswa’s example and start saving for retirement as early as you can. But even if you’re starting saving late, the most important thing is that you’re starting.

How much do you need?

Figuring out how much you should have saved is tough.

The general rule of thumb in South Africa is that you’ll need to be able to replace 75% of your income to retire comfortably. This assumption relies on the fact that you won’t have a home loan or any other large debt by that age, which means your monthly expenses will be lower. But, increasingly, financial planners are beginning to work on a 90% replacement ratio (especially since medical expenses tend to rise after retirement).

Assume you’re retiring today with a final salary of R40 000 a month (R480 000 a year). To replace 90% of your salary, you would need R10.8-million saved to maintain your standard of living (note that this amount also takes account of the 4% rule, which we will discuss in more detail in a later article). Most people will be very lucky if they have three-quarters of that.

Boosting your savings

So, if you’re nearing retirement and you’ve come to the conclusion that you need more savings to retire comfortably, you need to consider the following points:

• The easiest way to try to solve this problem is to save more. Aim to save at least a quarter of your net income. This is not easy and to do so you’re going to need to ruthlessly cut back on your expenses. Along with an automatic debit order into a retirement fund, saving an extra R1 000 a week on a salary of R40 000 a month will make a big difference.
• You’ll also need to be more aggressive when it comes to investing. A generally accepted rule has been to subtract your current age from 100 and have that percentage of your portfolio invested in equities – although these days many financial advisers advocate for the “110 rule” because we’re living longer. So, at age 30, you’d have 80%, at age 40, 70%, and so on. This de-risks your portfolio as you get older (you can’t afford a 50% crash in the markets at age 60!). If you start saving too late (or don’t have enough saved), you’re going to have to increase the equity portion of your portfolio. Consult a financial adviser though — the last thing you want is to make an uninformed decision and take unnecessary risk.
• Never cash out. One of the large financial intermediary houses said last year that 93.5% of its members in South Africa “who were paid withdrawal benefits in 2013 opted to take cash rather than preserve their benefits”. You can access savings in products like preservation funds and retirement annuities at age 55. At this stage, make sure your money stays invested (withdrawals from some products force you to purchase an annuity, for example). Don’t be tempted to use your money for non-essentials. By this stage you should be adding to your savings rather than eroding them.
• Finally, there’s also the option of working longer. But you don’t want to be in a situation where you’re forced to do so. Because we’re living longer, it’s not uncommon to continue working (even part-time) into your seventies. Will the concept of retirement even exist in a decade or two? Still – even if we stretch our working lives substantially in decades to come, surely it’s better to rather have saved a large amount of money, than not?

For more information on investing for retirement, speak to your financial adviser.

This article is part of an investment series by Discovery Invest.