It depends on how much monthly income you will require in retirement and how much you want your loved ones to inherit the day you pass on.
I often get asked: “How much is enough, and how much do I need the day I retire”? Well, that all depends on how much monthly income you will require in retirement and how much you want your loved ones to inherit the day you pass on.
The above sound like very mundane and obvious questions, but the answer to this will determine your capital requirements which will ultimately determine your investment strategy.
The next question is: “How do I achieve this?”
The big challenge is to decide today what your retirement income requirement will be sometime in the future. The closer you are to retirement, the clearer this answer will be. For someone who still has many years to retirement, this often seems like a pipedream, especially after we project future capital requirements when we take inflation into consideration. Telling a 30-year-old professional who earns R60 000 per month that to maintain their current income level at retirement (at 65), an amount north of R100 million will be required sounds like a bridge too far and an impossible dream, but alas, this is the reality of it and achievable.
Back to my opening questions. To assist with determining how much capital or wealth you need to accumulate by retirement, consider the following:
- One should aim to be debt free by the time you retire. Future purchases in retirement should be made with cash and not via debt. This strategy will reduce your monthly income requirement because there will be no bond or hire purchase agreements with the associated finance charges.
- No further contributions towards retirement funding, either via an employer or privately, will be necessary. Voluntary investments to fund purchases, emergencies, and holidays should continue.
- Life assurance premiums should be greatly reduced if your estate planning is in order when you retire. Life assurance should be reduced as your asset base grows. The same applies to short-term insurance premiums that should reduce as a result of consolidation. Smaller houses and smaller cars are cheaper to insure.
- Day-to-day costs should be less in retirement compared to your working life because, generally, you will travel less daily, spend less on unnecessary items and luxuries etc. Medical costs will, however, gradually increase.
- Hopefully, you will not have any financially dependent children the day you retire. Unfortunately, in today’s society, “sandwich families” are increasing, and adult dependents (parents and adult children) are becoming a common occurrence. This needs to be factored in.
Considering the above, your retirement income should be at least 20% lower than your pre-retirement income requirement. If you have a bond and car debt up to retirement age and settle it shortly before retirement and you scale down on your property, your retirement income requirement can be as much as 50% lower than your pre-retirement income requirement. You will also be able to assess this by considering the amount of free reserves you have available at month end currently.
For the sake of this exercise, let’s agree that your retirement income requirement will be 70% of your pre-retirement income.
On the second determining factor, let’s assume that you want to preserve all the wealth that you accumulate for your loved ones to inherit when you pass on.
To calculate future required capital, we must work with assumptions. There are no guarantees that the figures are going to work out exactly, but if realistic expectations are created, and realistic assumptions are used, one should get pretty close to the ball bark. If my guideline in terms of where you should be is followed, you should be okay when you retire. It is also important to remember that it is a work in progress and an “alive” model. It must be adapted and changed as your circumstances and income change over time.
Taking the 70% income replacement ratio assumption into consideration, the following table provides a guideline on how much you should have accumulated in investments and other assets (excluding your primary residence) as a multiple of your current annual salary. In other words, if you are 45 today, then according to the table, you should have accumulated the equivalent of 6 ½ times your current annual salary. Thus, if you are 45 and earn R50 000 per month today, you should have accumulated:
50 000 x 12 x 6.5 = R3 900 000 in investments and income-producing assets.
This is based on the assumption that retirement capital must be preserved for future inheritance. If this is not a requirement and you are happy that your capital will be depleted by age 100, then the provision amount can be reduced by approximately 20%. Note: The calculation is made for income drawn at 4.5% of capital value for capital preservation and at 6.3% for capital depletion. In both cases, income will increase at 6% per year with an expected investment return of 11% per year.
|Multiple of annual salary that should have been accumulated in total assets excluding primary residence
I expressly exclude primary residence from the accumulation calculation purely because no income will be generated from your primary residence unless you own a guest house as your primary residence.
Far too often we find a scenario where individuals rely on the value of their primary residence to supplement future income on the basis that the primary residence will be sold and a smaller property will be acquired at the appropriate time. Considering the selling costs, capital gains tax and purchasing costs of the new property, the profits are often insignificant.
Second and third properties must be included in your wealth calculation since they are considered investments which grow in value and provide rental income.
Another challenge is to determine what a realistic value is of a private company that you may own. It is not uncommon that, by far, the largest asset of an entrepreneur is their company. It is also not uncommon that entrepreneurs tend to fund their own businesses rather than external investments. It is, therefore, important for entrepreneurs to determine accurately the value of their business and include that in their total wealth when comparing their wealth accumulation with the multiple of the salary table above.
The question on everyone’s mind is: “How much do I need to put away every month to reach my goal?”
Monthly investment requirement to provide a pension equal to 70% of final salary
escalating at 7%
|Age at start
return per year
required per month
% of salary
The above table indicates that investment accumulation goals are very attainable. The caveat is that the earlier you start, the easier it is to achieve your goal, and the longer you wait, the bigger the challenge becomes. The above table also indicates the importance of returns and how much more needs to be invested monthly, with only a 2% difference in annual returns.
For most investors, their planning is a combination of the two tables above, where some funds have already been accumulated, but some clarity is needed to determine how much more needs to be invested to reach their goals.
Invest wisely and start early.
Article by Marius Fenwick – Wealth Up (Pty) Ltd