Last Updated on 08/07/2024 by Carl-Peter Lehmann
How much is enough to retire with is a question we often get asked? Can I retire with R5 million in South Africa today? How about R10 million? What’s the ‘magic’ number? Retirement is a significant milestone and determining if R5 million (or whatever number you have available to you) is sufficient requires careful consideration of various factors, including lifestyle, income needs, and retirement strategies. Let’s take a look at some of the key aspects to help you make an informed decision.
How Much is Enough?
The amount needed for retirement varies greatly among individuals. Factors to consider include:
• Lifestyle: Your retirement lifestyle goals will heavily influence how much you’ll need. Do you plan to travel extensively, maintain a modest living, or enjoy a luxurious retirement?
• Health Care Costs: With advancing age, healthcare expenses can increase. It’s crucial to account for these potential costs.
• Inflation: The cost of living tends to rise over time, so your retirement fund needs to grow accordingly to maintain your purchasing power.
• Longevity: People are living longer, and your retirement fund should last your entire lifetime.
That’s why performing a detailed cashflow analysis is so important to gain a deep understanding of what kind of monthly income you need to support the lifestyle you desire in retirement. And that is personal and different for everyone. We have clients with R30 million + retirement portfolios who worry about having enough, and others with R7 million in retirement assets that are content and comfortable.
Further Reading: Biggest Retirement Planning Mistakes You Should Avoid
Replacement Ratios: A Flawed Concept?
The retirement industry often uses replacement ratios to estimate how much of your pre-retirement income you’ll need in retirement, typically suggesting 75% as that ‘magic’ figure that will allow you to live in comfort. However, this concept can be flawed because:
1.Individual Variability: Everyone’s spending patterns and needs are different. That comes back to your cashflow and lifestyle you wish to lead in retirement.
2.Changing Needs: Your financial needs in retirement can change over time. Early retirement years might see higher spending on travel and leisure, while later years might have increased healthcare costs.
3.Income Sources: Replacement ratios overlook other income sources like rental income, part-time work, or investments.
You might be able to live comfortably off 50% of your final salary in retirement. Or it might need 90%. Everyone is different – so while throwing around ratios might serve as useful benchmarks and guidance while you’re working and need something to aim for, practically they have very little value and should be formulated around your needs and what’s important to you.
Consider Reading: The Best Balanced Funds for Retirees in 2024
How much does R5 million actually ‘buy’ you as income in retirement?
For the purposes of this exercise, you have R5 million in retirement savings you want to use to provide you with an income after retirement. To keep things simple, we’ll assume that there is nothing else in the pot so to speak.
And for quick retirement 101 recap remember you have to use that R5 million to buy an annuity. The annuity pays you the monthly income. And in South Africa we have 2 options:
i) Living Annuity where you take on the investment risk but have the flexibility of choosing your income drawdown level of 2.5% – 17.5% p.a. So if the income you draw is too high and/or your investments don’t perform well enough, you risk running out of money. The upside is that anything left when you die can be left to beneficiaries.
ii) Compulsory Life Annuity where you are guaranteed an income for life based on annuity rates (long-term interest rates or bond yields) at the time (with numerous variables you can add like required escalation rate etc.) So no investment risk but when you die the money is gone – with a few caveats you can add like guaranteed terms or spousal option.
R5 million from a Compulsory (Guaranteed) Life Annuity
Because long-term interest rates (bond yields) are attractive (relatively high) right now – using R5 million to purchase a life annuity today is quite an attractive option if maximising income, and not having to worry about investment risk, are your goals.
The table below shows the starting income available to you at ages 55, 60, 65; whether you’re male or female, and assuming a 6% annual escalation in income. (source: Old Mutual. Single life, 10-year guaranteed term)
Bear in mind that these figures change weekly, so you always want to be shopping around to see who is offering the best rates amongst the biggest and most secure insurance companies.
- So, the range of income you’re roughly looking at is approximately R30,000 – R36,000 gross per month depending on your age and whether you’re male or female.
- Ballpark, work on an average tax rate of about 20% to get you to your net monthly income figure – and decide whether you can afford to retire on that?
Read Next: What Makes Henceforward the Best Financial Planner for Retirees
How Does a Living Annuity Compare?
With a living annuity you have more flexibility around the level of income – by being able to choose a drawdown rate of between 2.5% – 17.5% p.a. – but here you’re taking on the investment risk. So, if your drawdown rate is too high and/or the underlying investments don’t provide you with sufficient growth, you run the risk of out-living your money.
Let’s begin by benchmarking (very roughly) how the above life annuity incomes translate into a drawdown figure from a living annuity. For simplicity’s sake we’ll use a nice round figure of R30,000 p.m. That translates to a starting drawdown figure of 7.2% p.a. Now, one of our major industry bodies (ASISA) have published a very simple table to show how long your capital will last (in years) before it starts to rapidly reduce and you effectively run out of money based on assumed investment returns and drawdown rates. This summarises the most relevant parts.
We were being generous with the 7.2% p.a. drawdown rate because the comparable figures on the compulsory life annuity are mostly well above R30,000 p.m. – so in reality drawdown rates are closer to 8%. But ASISA also only go in 2.5% increments – so for the purpose of this exercise we’ll simply go with 7.5%.
- Therefore assuming a 7.5% p.a. starting drawdown figure – your starting income is R31,250 p.m. income.
- Then you have to look at the investment returns (net of all fees). And if you’ve been paying attention – most investments in South Africa haven’t been doing all that well over the last decade (unless you’ve had a large offshore weighting).
- Returns have been modest and assuming a net return of 7.5% p.a. – which in the current climate is probably more than many retirees have been achieving once you deduct advice and platform fees – means your capital lasts you about 10 years. Even a generous 10% p.a. net of all fees return only gets you to 13 years.
Closing Thoughts
Comparing a complusory life annuity option that gives you R30K + per month for the rest of your life with less worry vs a living annuity which to match that kind of income means running out of capital potentially in as little as 10 years … you would think that there is only one obvious choice.
But we’re human and we don’t always make the most sensible or well- informed decisions, which can also be a function of unrealistic expectations, not fully understanding our options, or simply bad advice.
If you’re seriously weighing up a living annuity, you can see that even a 5% starting drawdown figure means that you’re at serious risk of depeling capital within 20 years.
If you have a realistic life expectancy of 30 years plus in retirement, you really shouldn’t be starting with a drawdown figure of higher than 4% on a living annuity. That means you need R9 million in retirement capital to start you at R30,000 per month or R10 million to start you at R33,333 p.m. (essentially double the capital needed to provide an equivalent level of income from a compulsory life annuity).
If your counter argument is that I’ll just invest all of my living annuity money offshore to generate higher reurns – that adds significant additional risk – and there are no guarantees we’ll see the returns offshore over the next decade as we have seen the last. The more conservative your assumptions to begin with, the better you’ll be.
In a lot of recent client conversations – R50,000 per month as an income needed in retirement seems to have come up a lot. For context on a ‘safe’ starting drawdown figure of 4% p.a. – you need R15 million in retirement savings. And that doesn’t account for income tax, so actually you need a fair bit more.
Now Read: Essential Investment Advice for Retirees
Carl-Peter Lehmann
Carl-Peter is a Director and Partner at Henceforward with over 20 years experience. He is a CERTIFIED FINANCIAL PLANNER who likes to help retirees navigate the complex terrain of navigating their options.
