Fund your Retirement

4 retirement traps to avoid

Retirement is an idea that’s woven deeply into the fabric of our culture but, like everything, it didn’t always exist. The short version is that retirement was born in the 1800s. Otto von Bismark of Prussia convinced the state that people who had worked all of their lives had a “well-grounded claim to care from the state.  The retirement age was pegged at 70 years, which was pretty much the average life expectancy for middle class back then.

So half the working population DIED before they stopped working.

That was back then.

Now we tend to think of retirement age as 65, but most developed nations or middle to upper-middle class people in developing nations like South Africa, can expect to live 15 years after taking the gold watch (which isn’t a thing anymore). That’s on average. You may live 30-40 years after retirement, and who knows where medical advances will take us between now and then?

Most people assume they’ll retire when they’re ready and live off the interest of their investments while they flyfish, or complain to the body corporate every day, but the truth is that a successful retirement requires planning. This article will dispel some of the major myths about retirement, and point you in the right direction.

Myth 1: You get to retire when you want to

We’ve always thought of retirement as a thing we do one day when we no longer earn a salary. With a definition like this, you may think that you’ll never retire, at least not if you expect to keep working forever. The problem is getting the timing right. In an ideal world, we decide when to stop working, how our health holds up and what the job-market for senior widget makers is.

Unfortunately it’s not as simple as deciding to work forever, as many people are forced to retire much earlier than they had anticipated.

Alternatively, retirement could be thought of as not what you do when you stop working; rather, it’s what you do when you’re no longer able to work. This definition is perhaps more appropriate than the first, as it introduces the concept of a non-agreed-upon retirement date. To assume that you’ll get to retire on your terms is misguided.

Perhaps retirement should be approached as nothing more than an unknown and extended period of time wherein you’ll never earn a salary, necessitating the mother of all emergency funds?

Saving for an emergency fund was easy in that we got to define the required amount. But how does one save for being unemployed, for forever, and not knowing when forever starts?

Myth 2: You’ll pay less tax in retirement

South Africa’s income tax system is a progressive one, meaning that how much tax you pay is largely based on how much you earn. There are small additional rebates for taxpayers over the age of 65, but these are far from life-altering.

How much tax you therefore pay in retirement, depends on the nature and amount of your future income.

It is not uncommon to find retirement planning rules of thumb that tout an income replacement ratio or strategy for retirement of between 60% and 80%. Simply put, this is the percentage of your working career salary that you’d be happy to receive whilst in retirement.

If you’ve taken the time to draw up a plan, it might be easy for you to get an idea as to what kind of income replacement ratio you might need (or could realistically achieve), but to assume without proper analysis that yours would be any less than your current income, is naïve.

To reduce your current monthly income needs would require to you either settle some notable debt balances, cut back on any savings initiatives you have, or cut back on your quality of life.

If this is not a credible option for you in retirement, then don’t suddenly expect to pay less tax.

Remember too, that if your retirement planning was based largely around contributions to a retirement annuity, then once you annuitise and enter into a living annuity, all that income will be subject to marginal income tax rates.

Myth  3: Retirement means never touching your principal, and living only off of the interest

It is romantic to think of being ‘financially secure’ as being that later time in life, whereby you’ve accumulated your nest-egg, and being the responsible retiree that you are, you never touch the investment principal, instead you chose to live only off the interest or investment returns.

This might have worked way back when, but nowadays real rates of return on cash and bonds are woeful, especially when you stretch out the investment term. Coupled with steady inflation, expect to see your retirement balance shrivel.

An inflation rate of 7% would see your retirement balance halve in purchasing power (‘PP’) terms in 10 years.

We think it fair to assume that it’s not impossible that many of us could be around at least 20 years after retirement, which means a retirement balance of a quarter from when you started (in PP terms), in the absence of a real return.

There are very responsible ways of drawing down against your investment principal to subsidize your income needs and this should not be ruled out, unless you’re fixated on leaving all your wealth to your kids – or cats.

Which takes us fittingly into…

Myth 4: Retiring means no longer having to think about the long-run

Contrary to how you might feel about retiring, the words ‘the long-run’ still has a great deal of relevance for you.

People are living longer, and it’s certainly not unheard of for someone to need to draw down against retirement savings for between 30 and 40 years.

When you’re dealing with timeframes that long, you absolutely have to accept a degree of investment risk within your investment portfolio in order to earn a return that is capable of generating real growth in your portfolio.

Gone are the days of super-safe investment portfolios with exposure to only cash and bonds. ‘Super-safe’ means a slow and steady loss of purchasing power due to inflation.

Risk is ultimately needed, and it has generally only been shares that have consistently provided real returns over the long-run.

It may feel uncomfortable to start talking about having adequate exposure to risky assets in your portfolio, but risk is your friend. If you can accept that, the conversation can then move to one about managing the risk, with clever strategies like diversification.

Simply put, your best bet when it comes to retiring (whatever that might mean), would be to engage the services of a marvelous financial planner who can consider your investment portfolio and the asset classes that you’re exposed to, and ensure that they’re wholly appropriate for your needs.

Retirement used to be about preserving your wealth for 15 years or so, and you dare not lose any capital as there might not be time to earn it back. What’s ironic now that a zero-risk investment portfolio could be the one that does the most harm.

Don’t wait until you’re too old to work

You have to put some thought into your retirement. You may plan on launching the next big app that makes kabadillions of dollars, but that’s what we in the financial industry call “high risk”. Rather read some of the articles we’ve linked to above, and speak to a financial planner who can help you come up with a proper strategy.

The Editors

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