4. How to save for your retirement - even if you have left it late
Question
I am 42 years old, earn R40 000 a month and have not saved anything for retirement.
How much do I need to retire on and what should I do about it?
Answer
The amount of money you need to retire on depends on how much you intend spending in a typical month when you are no longer working.
A simple way to do this is to look at your monthly budget (and if you don’t have one and need a template, drop me a line and I will forward one to you).
Mark all the things in this budget that you will not need when you retire. These will typically include your bond if you plan to pay off your home loan by the time you retire and school fees if you do not have a “laatlammetjie”.
Go through the budget and mark the items that would reduce. Then identify those which would increase like medical costs. This exercise should give you good indication of how much you will need to live on each month.
For example, if you go through this exercise and you determine that you will need R20 000 a month to live on when you retire. This will translate to an amount or R240 000 a year. To generate R240 000 a year, you will need an investment of R6 000 000 assuming a 4% drawdown.
A nice rule of thumb to give you an indication of how much you will need to generate a monthly oncome is to multiply the desired monthly income by 300. In this example, you take R20 000 x 300 = R6 000 000
Remember each person’s circumstances are different. Most financial planners have sophisticated financial planning software that will work out what you need and model the best way to meet that. I would recommend that you talk to one.
The government has a great incentive scheme to encourage you to save for your retirement. They will allow you to contribute 27.5% of your income to retirement savings and reduce your taxable income by this amount up to a maximum of R350 000.
Someone earning R40 000 a month will be allowed to contribute up to R11 000 a month to a retirement annuity (or provident fund or pension fund) and have this full amount deducted from their taxable income. This means that the R11 000 investment effectively costs you R7 040 once you take the tax saving into account.
If you flip this calculation around, a R7 040 investment buys you R11 000 in a retirement annuity. This equates to a 56% return. It makes sense to get the receiver of revenue to help you save for retirement.
Another attractive feature of retirement annuities is that the growth within the fund is tax free. There is no capital gains tax or tax on interest payable. This further enhances your returns.
There are restrictions that you must bear in mind when investing in a retirement annuity. The overall investment portfolio cannot have more than 30% offshore, 25% in listed property and 75% in equities. You will not be allowed to access your retirement annuity savings before you turn 55. When you do, you will have to use at least two thirds to buy a monthly pension.
The immediate tax relief and the tax-free growth make retirement annuities a powerful financial planning instrument for people of all ages.
Young people benefit from the tax-free growth and the compounding effects of the investment. I have an example where a 25-year-old contributed R1 000 a month to a retirement annuity for 10 years and stopped at the age of 35. When she retired at the age of 65, she had more money than her twin sister who started contributing R1 000 a month at 35 and continued contributing for 30 years till the age of 65. Compound interest and tax-free growth is a powerful combination.
If you are over 55, the age restriction for accessing the funds is not a factor. I ensure that all my clients make use of the full 27.5% allowance if their cashflow allows it. At the end of each tax year I do the calculation to see what can be contributed as a lump sum to make up the 27.5%.
A R100 000 investment for someone at the top 45% tax bracket will effectively cost R55 000 after tax. In other words, a 55-year-old can invest R 55 000 in a 1-year RA and receive a R100 000 investment that can be cashed in a year later. If the value of the fund is less than R247 500 then the full amount can be taken out as a lump-sum
Retirement funds do not form part of one’s estate. RAs are therefore a great mechanism to remove capital from one’s estate while at the same time keeping a measure of control over it
Your investment in a retirement annuity will therefore get the government to subsidise your retirement savings, provide you with tax-free growth and reduce your estate duty. This is a great way to save for your retirement.
Kenny Meiring MBA CFP ® is an independent financial adviser. You can contact him on 082 856 0348 or at Financialwellnesscoach.co.za