The retirement savings catch-up guide: Making up for lost time
Approaching retirement can be as daunting as it is exciting. Even the most well-prepared can feel anxious about the idea of moving from earning money and accumulating savings to living off those savings. But what happens if you are not prepared financially, is there anything one can do to make up for lost time?
The good news, according to Andre Tuck, Senior Investment Consultant at 10X Investments, is that there are quite a few options one can explore to give your retirement plan a boost in the final few years of saving.
"For many, this will be a time when cashflow is freed up because children have left home and perhaps the bond has been paid off. They will have the option to save aggressively during their final years of work. But those who are not in a position to engage super-saver mode will have think more practically."
Tuck says that a good place to start is to draw up a reasonably detailed budget covering your essential costs and other expenses. At the very least, this should cover accommodation, food, healthcare, insurance, transport, communication, entertainment, travel and leisure, and emergencies.
"This will help define your ultimate savings goal: the amount of money you need to have saved to sustain your lifestyle in retirement."
Determining your savings goal
One approach to determining your savings goal is to work backwards from a sustainable draw-down rate of 5%. Based on ASISA guidelines, investing in a high equity portfolio and drawing down at 5% initially (including fees), growing with inflation thereafter, gives you a very high probability that you will be able to maintain your lifestyle throughout retirement, despite market fluctuations.
"According to this approach, if your initial annual drawdown of 5% would cover all of your expenses (including your investment management fees), you are on the right track," says Tuck.
Another approach is to input your details (age, income, existing savings) into an online retirement saving calculator, such as the one on the 10X Investments website, and let it work out your savings goal.
Tuck says: "If you choose to go into super-saving mode, you could still make a big difference over the last 10 years of your working life, but it will probably require some lifestyle sacrifices. By making these sacrifices now, you are also providing for a smoother lifestyle transition from pre- to post-retirement.
"Doing this alignment sooner rather than later avoids a much steeper drop-off in lifestyle during retirement and will be worth the sacrifices you make in the last stretch of your working life."
Delaying your retirement
Some people are obliged to retire at a certain age but if you can choose to work for another two, three or five years, Tuck says, you will give yourself those years back threefold.
"You have extra years to save, your investment has more time to grow, and you have another 3 years when you are not drawing down on your savings."
Keep fees low
Not enough people focus on the amount of their retirement savings they are paying away in fees, says Tuck.
Paying an additional 2% in fees, or even 1%, over a saving lifetime takes a disproportionately large chunk out of your savings total. "You lose not only the extra rands you pay in fees but also the growth on that money. Paying high fees has the opposite effect of compound growth. It creates a gap in your retirement pot that grows over time."
The tyranny of compounding costs is less severe over shorter periods, but paying 1% pa less in fees over the last 10 years of your savings life would still give your final savings a material boost.
Choosing the right annuity
A big decision that retirees face is the type of product they will transfer their savings into to pay them a pension. Members of retirement savings funds must use at least two-thirds of their fund proceeds to purchase an annuity, either a guaranteed annuity (also known as a life annuity) or a living annuity.
A life annuity pays you a guaranteed monthly pension for the rest of your life. It’s a form of insurance that protects you against poor investment returns and the risk of outliving your savings. The downside is that you have no control over how your money is invested, nor can you choose to increase or decrease your income should your circumstances change. Also, your investment dies with you i.e. no money passes on to your heirs.
Tuck says it is largely for these reasons that a significant majority of South Africans choose to invest their retirement savings in a living annuity. "In an LA, investors have some input into how their money is invested and can decide, within certain limitations, how much of their savings they draw down as income every year. They also get to bequeath whatever is left of their savings to their heirs."
He warns, though, that the other side of this flexibility is the risk and responsibility of securing an adequate income for the rest of their life.
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Here, too, fees are an important consideration. "If you manage to pay just 1% pa in fees instead of 2% pa on your living annuity, in the context of a 5% draw-down rate, you would effectively increase your income by 33% (from 3% to 4% of your savings)."
Choosing the right asset mix also matters. "Our inclination is to invest defensively (government bonds and cash) in retirement, as these are likely to deliver more reliable returns than shares, and you won’t have to worry that a market crash will dent your savings. But they may not deliver the long-term returns you need to fund your retirement, especially if your savings fell short of your goal."
Historically, over periods of five years or longer, a high equity portfolio has typically delivered a better return, with less downside risk, than a medium or low equity portfolio, even though the annual returns were more volatile.
"As most retirees have a time horizon well beyond five years, choosing a high equity portfolio is another way to extract more income from their savings," says Tuck.
Deciding between a living and a guaranteed annuity is an important decision that depends on an individual’s personal circumstances, including (but not limited to): how much they have saved, desired income in retirement, health, age, life expectancy, the needs of a financially dependent spouse and potential bequests.
This an important decision will almost certainly have a bearing on your lifestyle in retirement as well as having tax and estate planning implications.
The content herein is provided as general information. It is not intended as nor does it constitute financial, tax, legal, investment, or other advice.
This post was sponsored by 10X Investments and created by BrandStudio24 for Business Insider.