South African retirement savers who get things right on day one of their journey to retirement have a better chance of achieving a financially independent retirement than their peers.
This is according to Kobus Hanekom, head of strategy governance and compliance at Simeka Consultants & Actuaries, who observes that savers will not get a better opportunity to bullet-proof their retirement strategies than on the first day of employment.
He adds that employers HR departments, along with their employee benefits consultants, have a duty to put savers on the path to retirement success as early as possible. “There are many waypoints along the retirement journey where you can rectify your early mistakes, he says. “But you will never have as good an opportunity to get things right as on day one.
The study of human behaviour offers some answers as to why the average saver struggles to save enough for retirement. “We appear to be hard-wired to respond to short-term events that occur tomorrow or the day thereafter, rather than contemplate something that will take place three or four decades down the line, notes Hanekom. This shortcoming highlights the need for guidance at an early stage in the retirement planning process.
The formula for a successful retirement is simple and you only need to consider four components, namely the level of your monthly contribution, how long you make contributions for, how much return you earn on your accumulated savings and your salary inflation.
Based on current projections the recommended formula is for employees to put away 12.5% of their remuneration over a period spanning 40 years. You then need to have faith in the actuarial projections of investment returns and salary increases.
“If you are Mr or Ms Average, you will probably find that your salary increases at a rate of CPI +2% over the course of your working life, says Hanekom. He adds that the consensus on achievable investment return over this period is currently CPI + 5.5%.
“If you contribute 12.5% of your salary after costs and contributions to risk benefits and achieve CPI +5.5% over 40 years, you reach a magical projected pension ratio (PPR) of 75%, says Hanekom. The group favours PPR over the traditional net replacement ratio as a more accurate measure of what you will actually need to get by on in retirement.
Employees who come up short on the above measures could face serious shortfalls at retirement. For example, if the return in your fund falls by 1% to CPI + 4.5%, your PPR falls from 75% to 68%, while someone who retires at age 60 instead of 65, thereby missing out on the final five years of compound interest and contributions, will see their PPR drop to just 60%.
“The secret to a good retirement outcome lies in adopting an appropriate retirement strategy at the start of your working career and sticking to it, says Hanekom. This fact is easily illustrated by considering the uphill battle a late starter faces.
A saver who contributes 8.5% (as opposed to the suggested 12.5%) to a retirement plan from age 25 to 45 would have to put in around 18% of salary from that point forward to reach the 75% magic number. If you start with zero savings at age 45 you will have to contribute 29% of your salary to achieve a 75% PPR at age 65, because a 12.5% contribution would only get you to 26%!
A worrying statistic from the latest SEB Benchmark survey is that employees only begin looking for retirement savings advice on average 11.2 years before retirement. “If you leave savers to their own devices they wait until it is a bit too late before they take corrective steps, says Hanekom.
He adds that it is very difficult to fix a retirement plan at age 45. In such cases the focus may have to shift from saving “enough, to adjusting your lifestyle in order to get by on less or taking a decision to work longer before retirement.
25 March 2014
By Kobus Hanekom, Head: Strategy Governane and Compliance