How do you form a realistic idea of what your retirement needs will be?
We refer to the replacement ratio -the percentage of working income that an individual needs to maintain the same standard of living in retirement. As we generally don’t have the same level of expenses in retirement as we have while employed we generally only require, for example, 75% of our working income to maintain our standard of living. A replacement ratio of 75% is the industry’s accepted norm (Which very few South Africans achieve!).
This is an easy calculation when we are close to retirement but quite difficult at the start of our career. This leaves the person at the start of their career with a conundrum as to how much to save.
Now obviously saving more will provide for a better retirement than saving less but we still wish to have an acceptable standard of living during our working years. As a rule of thumb we should aim to contribute at least 15% of our income per year toward retirement.
Make the following assumptions:
- We are either 10, 20 or 30 years from our intended retirement date
- inflation averages 5%
- we increase our debit order by 10% per year
- capital grows at 10% per annum
We will need to contribute the following to achieve the indicated income per month, adjusted for inflation.
This illustrates the benefit of starting sooner rather than later. Certain forces are working against us though. In the examples above the contributions and growth are assumed after tax and after fees which means that the figures indicated are in fact an understatement of our actual required contributions and growth.
Luckily we are not unarmed when it comes to combating these negative forces. There are products and investment vehicles available that can minimise the fees you incur when investing or provide very advantageous tax benefits or indeed both.
We will begin to cover these products in the next post.
