How much do I need to retire?
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2012
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08
Feb
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New perspectives on an age-old problem
Although many financial planners suggest that households should plan to retire on 75% of their income at retirement, new research suggests an entirely different approach.
Megan Butler, Research Actuary at Alexander Forbes and lecturer at the University of the Witwatersrand, considered the income and expenditure profiles of almost 3000 households and found that contrary to popular belief South African households do not reduce consumption voluntarily on retirement. In fact, for certain households, consumption increased in retirement due to higher health expenditure. The lower expenditure of retired households that is seen in practice may well be a result of pensioners having lower incomes than what they had while working. These pensioners are thus forced to reduce spending. “If not limited by their lower incomes, these households would spend at similar levels to what they did while working” argues Butler.
Butler’s research, conducted as part of her Master of Science at the University of the Witwatersrand, Johannesburg, considered the lump sum that would need to be accumulated at retirement in order to avoid households being forced to reduce consumption at retirement. The results suggested that households need more than previously thought and that retirement needs differed dramatically between different types of households.
In South Africa, retirement adequacy is typically measured by a replacement ratio which gives the income in the year after retirement as a percentage of the income in the year before retirement. Many calculations are performed using pre-tax incomes and most funds use targets of between 70% and 79%. However, a gross of tax replacement ratio target of 79% was inadequate for at least 82% of single females and at least 88% of single males.
If couples were considered, the results were better, “particularly if the younger partner continued working after the older partner retired. That said, only about half of couples would find a target of 79% enough to avoid a consumption drop at retirement” added Butler.
Although the development of a complete set of retirement benefit targets for South African households requires further investigation, the results have important implications for individuals, retirement funds and financial planners.
Firstly, while people may require more to retire comfortably than previously thought, households can improve their position in retirement by:
· Retiring later or having some form of part-time work in retirement;
· Increasing retirement savings rates;
· Increasing the return on investments subject to an acceptable degree of risk; and
· Consider having the younger partner continuing to work after the older partner reaches retirement age.
The research suggests that these higher targets are obtainable if households are willing to save about 10% to 15% of their total incomes. In future this will be achieved by:
· Adopting a lifecycle approach to help people save more effectively as their careers progress.
· Not dipping into their savings before retirement.
· Electing to work until the age of 67
· Preserving retirement savings when changing jobs
Secondly, it is unlikely that there is a single target that is appropriate for all households. Households needed to have accumulated in the region of 14 to 18 times annual salary at retirement age 60. This reduces to between 12 and 17 times at retirement age 65, and between 10 and 15 times annual salary at retirement age 70.
Single women needed to accumulate more than single men and for couples the sex of the household head made a difference to what the household needed to retire comfortably. This result was driven by the different life expectancies of the households and the fact that households spend differently, “highlighting the importance of personal financial planning” says Butler.
John Anderson, Managing Director for Research and Product Development at Alexander Forbes, added that “this research supports the holistic lifecycle approach that Alexander Forbes is embracing.”
As each household is different, individuals need to take control of setting financial goals and then use financial advice and planning tools to ensure they remain on track to meet these goals. As far as corporate employee benefit arrangements are concerned (including employer sponsored retirement arrangements), the research suggests that it is desirable “that benefit designs allow for individuals to tailor arrangements for their specific needs” said Anderson.
This flexibility is at the heart of a lifecycle orientated approach and lends itself to offering members structured advice facilities and simpler menus of choices, allowing individuals to better align their benefits to their needs.
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