As human beings we tend to focus on the here and now, not realising that by failing to plan for the future we are planning for failure. Thinking about retirement leaves people with different levels of enthusiasm about the years during which they should be enjoying the fruits of their labour. For those that still find themselves early in their working life it feels like something that is too far in the future to give much thought or attention to. Even those in their mid-career get caught up in the development of their career and increasing family obligations, which results in insufficient attention being paid to their financial future in retirement. Only when many people are ten years away from retirement does the reality of having to have sufficient retirement savings come to the surface. This presents the greatest single challenge to retirement planning and ensuring financial independence.
Planning for retirement is not a single event in one’s life, but rather a journey that should be planned for throughout your active working life. The reality for most individuals is that they will spend between 20 to 30 years in retirement. These years need to be funded by an average work life of between 40 to 45 years. Given the uncertainties of life and the continuous rise in the cost of living, we need to maximise the opportunity of building up sufficient capital for retirement during our active working years. This requires an integrated investment and savings plan for your in-retirement phase.
Retirement planning should focus on two broad stages of your life – pre-retirement and in-retirement. The focus for pre-retirement planning involves the creation of wealth with the objective of accumulating sufficient capital for financial independence at retirement in order to maintain your preferred lifestyle during retirement. During this stage it is important to start with the end in mind by determining how much capital you will need at retirement to maintain your desired lifestyle during retirement. You then need to calculate what annual rate of return you require over the period of time to retirement and the amount of money you will be able to save on a monthly basis. The investment strategy must then be designed around the objective of achieving the required rate of return and to grow your capital in real terms for the day you retire. The main pre-retirement savings vehicles you can use to build capital include the retirement fund of your employer, a preservation fund, a retirement annuity and discretionary (after tax) savings products.
Moving into retirement demands a shift in focus, as you will start consuming your wealth during this phase. The investment strategy for the retirement phase must allow for the protection of your capital base through stability and continued growth to counter inflation and the drawdown of capital as a result of the monthly income taken. As you enter retirement, you need to re-assess various aspects of your personal finances and your lifestyle choices. Decisions need to be made regarding the type of retirement product you will use to receive your retirement income, as well as how that investment will be structured. If you were a member of a retirement fund, you are legally bound to use at least two-thirds of the capital to buy an annuity. The remaining third of the capital can be taken as a lump sum and can be used to settle any remaining debt or fund an additional income stream with the first R500 000 of the lump sum being tax-free.
The main challenge during retirement will be to make your capital last for as long as possible. How long your capital lasts will depend on the percentage income that you draw from your investment, as well as the investment returns you achieve on your capital during retirement. At retirement you will have to choose the type of annuity product that will provide your monthly income, which can either be a living or a life annuity. Selecting the right product is very important and will depend on various factors relating to your personal circumstances and preferences. It is suggested that you discuss this decision with your financial advisor at least seven to eight years before your planned retirement date.
A common mistake made when planning for retirement is that the investment strategy is designed around the date of retirement. The retirement date is worked towards as a definitive point after which a completely new strategy is devised for the retirement years. The result is that your retirement capital ends up being invested in cash at the date of retirement. Following this strategy is correct for people looking to buy a guaranteed life annuity at retirement and if the guaranteed rates offered at the time of retirement are favourable.
However, if you are considering investing in a living annuity, where you can adjust your investment strategy and monthly income according to your needs, then moving to cash at retirement is not advisable. The way you can avoid missing out on growth, if considering a living annuity, is to stretch your investment horizon beyond retirement. This will result in a smooth transition of your pre-retirement investment strategy as you move into retirement while staying invested in the markets.
Wherever you find yourself on your retirement journey, it is never too late to take control of your financial independence, even during retirement.