Are you saving enough for retirement?

9/4/2007 12:28:11 PM

Over the last few weeks we received quite a number of enquiries regarding retirement annuities, provident funds and other retirement savings vehicles. This made me think that it may be a good idea to cover the topic of options available for retirement savings.

To start of it is said that South Africans don’t save. As a nation we save less than 1% of our disposable income and you may have read in the papers over the last year what government is trying to do to improve this, reducing taxes on interest earned and on retirement funds. You may ask but why is it important for us as a nation to save. Presently South Africans are borrowing money at an alarming rate which basically means we are spending more than we earn and in effect borrowing from the future thus creating inflationary pressures which is negative for our economy. It is a well known fact that leading nations has a strong savings culture which creates capital for companies and other smaller organisations to expand and thus grow the economy and create new jobs.

But enough about the macro economic stuff. I want to address the issue of saving for retirement. Most employed people have some or other pension type product provided by their employer. Most of these are what we call a defined contribution plan. This means that the employer contributes to your retirement fund as do you. However, once you reach retirement the employer (or fund) gives you the saved amount plus growth, and of course your golden watch for 30 years service and you will have to buy your own pension.

The problem is however that in most cases the funds saved through your pension or provident fund will not be enough to provide for your financial needs at retirement. Most financial advisors will tell you that you will need between 8 to 10 times your annual salary at retirement. If you earn R100 000 per annum this means that you will need  between R800 000 to a million rand for retirement. In my experience this is not enough.

Lets use the following example. Most people contribute +/- 7.5% of their gross salary to their retirement fund and the employer a similar amount. Lets say Mr Crock earns

R100 000 per annum. This means he contributes R7 500 and his employer contributes

R7 500 per annum to his retirement fund. Lets say  Mr Crock is 30 years old and expects to work till age 65. Mr Crock thus has 35 years to save for retirement. If we make the assumption that he can earn a return on his investment of inflation plus 6% or lets say 12% per annum, he would have saved R8 038 699 by his retirement age. Sounds a lot doesn’t it. Reality is however that this amount is the equivalent of R1 045 785 in today’s money if you assume a 6% inflation rate.

A realistic withdrawal from a retirement fund is 5-6% of the capital if one wants to ensure that your pension income keeps track with inflation and don’t want to deplete the capital too fast. In our example this means that Mr Crock will have an income of between R4 357 and R5 228 per month in today’s money. This is only 50 – 60% of his required income of R100 000 per annum. Mr Crock will have to save more to ensure he has enough to provide for his retirement. But what options does he have?

There are numerous discretionary and retirement savings that Mr Crock can make but I want to discuss saving using a retirement annuity. Although the old generation retirement annuities are under fire lately the new generation retirement annuities have many advantages.

The new generation retirement annuity is called a unit trust linked retirement annuity. This means that you can select the underlying unit trusts you want to invest in. Furthermore the costs are calculated differently. With the new type annuities the broker will charge you what we in the industry call an as and when fee. This means that instead of paying the full cost of the broker up front, like with the old annuities, and therefore losing a lot of compound returns over the long run, you pay a fee on every premium which is usually a small percentage of the premium.  

The other advantage is that the tax dispensation in the retirement annuity makes it very attractive for saving. Presently there are no tax payable on any income earned inside the retirement annuity and there are also no capital gains tax on these products. This means that not only do you receive a tax brake on the premiums you pay monthly but the returns earned inside the annuity are also not taxed.

You may ask what is the catch? When you retire you will then be taxed on the income you withdraw from your retirement annuity but as you may fall in a lower tax bracket you may pay less tax and the return on your investments inside the annuity will go on tax free.

So how much should and can you contribute? The “how much can you contribute?” question is easy. How much can you afford? How much should you contribute is determined by two factors namely how much non pensionable income do you earn and secondly what is your retirement shortfall?

The first question refers to how much of your premiums will be tax deductible? The portion of income not used to calculate your pension contribution i.e bonuses or commissions etc is used for this calculation. The tax legislations allows you to contribute up to 15% of your non pensionable income tax free. This means that if Mr Crock earned a bonus of R20 000 he will be able to contribute R3000 per annum tax free to a retirement annuity.

The second factor namely what is your retirement shortfall is calculated by the difference between what you need as capital at retirement and what your present retirement savings will produce. Your financial advisor will be able to help you with this calculation.

Maybe one point of advice, make sure you do not mix savings for retirement and life cover. Keep it separate.