It may seem that these variables are unpredictable. However, this can be modeled, based on your present salary and contribution rate, current annuity prices, and the projected long-term real (after inflation) returns on a balanced life-stage portfolio. Below, we take you through this process.
In Figure 1, we first quantify the cost of R1 of annuity income (based on the Sanalm Investment Management annuity rates at 1 September 2013). We do this by inverting the current annuity yield (the amount of annual income you receive for, say, R1m). The later you retire the cheaper every rand of annuity income becomes. So a man of 55 will pay R18.10 whereas a man of 65 only R13.90. This is for an inflation-linked annuity, for a single person.
Fig 1: Cost of R1 of annuity income
We can use this information to quantify how much you need to have saved, to buy an inflation-linked annuity that replaces 60% of your final salary. By multiplying the annuity cost by 60%, we can derive the multiple of final salary required to achieve this income. A single male aged 65 would require savings of 8.3x final salary, a male aged 55 savings of 10.9x final salary.
Fig 2: Savings as multiple of final salary required to achieve a 60% final IRR
Our previous blog assumed that you had saved the same amount irrespective of whether you retire at 55 or 65. That is not a reasonable assumption of course; when you retire early, you not only receive a lower annuity for your lump sum, but your lump sum will also be smaller because you have made fewer contributions and earned investment income for a shorter period. So your post-retirement living standard will have to deal with this triple whammy.
We use an example to quantify the potential blow. Our base case assumes that you (a male) start saving at age 25. You earn R20 000 pm, growing annually at 1%. We ignore inflation, so this reflects your real salary growth. Your contribute 15% to your retirement fund, and you earn a real (after-inflation) return in your retirement fund of 5% pa, before fees. We initially assume you pay fees per the 10X RA or Preservation Fund fee scale (starting at 1% pa for amounts below R1m, falling to 0.7% pa for the next R4m). The projected savings outcome is calculated with the 10X Retirement Calculator. Again, we use the Sanlam Investment Management annuity rates as at 1 September 2013, to calculate what annuity these savings would buy, and how much of final income this would replace.
Fig 3: Projected final IRR at different retirement ages
In Fig 3 above, we graph the projected replacement ratio you would achieve based on the above savings strategy, and the current cost of an inflation-linked annuity. The line for the hurdle replacement ratio of 60% is in bold. At age 55, the replacement ratio is only just 40% – at age 62 (seven years later) you would achieve a replacement ratio (retirement living standard) that is a full 50% higher! Retiring a few years early thus comes at a heavy cost, just as retiring a little bit later, say at age 67, translates into a significantly higher retirement income.
We often point out in our blogs that mistakes compound – people start saving too late, they save too little, they pay too high fees and they do not invest risk-appropriately. The compound effect of these mistakes literally decimates your retirement income.
Below, we show the impact on your final income replacement ratio if you paid an annual fee of 3% on your retirement investment rather than 1%. Based on our example, a single male planning to buy an inflation-linked annuity with a 60% IRR could retire at 61 with the 1% fee, or at age 68 with the 3% fee. Effectively, he would have to work another seven years, to meet his retirement goal (or, more bluntly, to support the service provider!)
Fig 4: Projected final IRR at different retirement ages
Where are you relative to your savings goal?
The variables that determine your retirement income and your projected final income replacement ratio change continuously, in response to changes in interest rates, annuity prices, your salary and contribution rates and the investment return earned on your accumulated savings.
To stay abreast of your personal savings progress, and to assist with your retirement planning we recommend you make use of the 10X Retirement Calculator. This will project your total savings at your expected retirement date (in real terms) as well as the final income replacement ratio this will support, at prevailing annuity rates.
You can flex the assumptions (retirement date, contribution rate, target IRR and projected investment return) to see how this will impact your savings goal.
