First published in Estate Living magazine & online
Planning for retirement can be both exciting and scary. Exciting in the sense that you’re planning for a life event that is spoken about so often throughout ones life that it’s really a milestone and period to look forward to. Scary though as you never knows whether you’ll have enough as it’s impossible to predict the future. So much could go wrong in our economy and even if you’ve invested offshore, nothing is certain!
There are however some “rule of thumb” calculations to help you plan for retirement and creating additional incomes streams now that can see you through retirement will obviously help tremendously!
The “rule of 25”
This is a simple theory that if you know what your annual living expenses are, and you multiply it by 25, you will have the lumpsum figure that you should have invested before you retire. If you’re married and share expenses then you should probably do the calculation with your combined expenses. Even though one partner may retire before the other we don’t need to overcomplicate things as this is a “best guess” calculation after all. Also consider if any of your current monthly expenses would fall away when you retire.
As an example, if you monthly expenses amount to R23,000 you would simply multiply it by 12 to get your annual expenses of R276,000. Multiply this by 25 and you’ll see that you will need R6.9 million in order to retire and maintain the same lifestyle that you currently do. This figure can obviously be spread across investments but the house that you live in does not count towards your retirement funding unless you’re planning on selling or renting it out.
Generally speaking one would not want to take any debt you have into retirement with you. If this is your plan then do this calculation without any monthly debt payments you may have now and you’ll need to be certain that you debt is settled before crossing the threshold to a new phase of life.
How does this work?
The “rule of 25” works together with another assumption which is that your investments will grow by 7% per annum while you only withdraw 4% per year for your expenses (adjusted for inflation). You’ll see that 4% of R6.9 million is exactly R276,000 which are your annual expenses for the year. The flaws however are that one’s growth is never guaranteed and inflation rates change. Doing the calculation with an inflation rate of 4% and an annual growth of 7%, your money would easily last 35 years and more. Increase the inflation rate or decrease the growth and your money will run out sooner though.
The opposite is also true that a higher average growth rate along with a lower inflation will cause your money to last much longer. Some followers of the “FIRE Movement” (Financially Independent, Retire Early) have adjusted the calculation to rather assume a required lumpsum of 30 times your annual expenses. This is a larger investment but provides greater peace of mind.
The calculations are actually quite fun if you plug them into a spreadsheet and adjust the annual growth and inflation figures and it’s a good idea to relook at this every year or whenever major changes in your finances occur. You can download a spreadsheet to help with the calculations at Take Charge of Your Money – How much do you need to retire?
How to retire on less?
While we can’t do much about inflation nor growth on our investments, we certainly can cut down our expenses. It’s not a bad idea to do this same calculation with the minimum expenses you are willing to survive on and see how the final number reduces. Decreasing your expenses now already will also mean that you can put more towards your investments and retire with more security.
If you could survive with R3,000 a month less each month you could reduce your lumpsum investment by R900k.
Earning income while retired
Passive income as you know can make a huge difference going forward! Using the same example with annual expenses of R276,000 we can reduce our investments needed before we retire by R2.4m if we happened to be receiving a monthly rental of R8000. This is simply because we have an income stream to supplement the expenses. The calculations do unfortunately get more complex if you have a bond that you are servicing on your rental property but you can simply look at your net income which should hopefully increase each year.
Property isn’t the only form of passive income and it’s important to focus on creating income streams that are not solely dependent on your own time & effort. As you get older you would want to pay someone to manage whatever business or venture you have, or pass it on to your children if you’re able to do so.
Retirement is certainly not the end of the road as some people make it out to be! It’s a time to pursue new interest and take on challenges. The major shift-of-mind when retiring is that you no longer earn a fixed salary. If however you can generate enough income from other sources that will cover your expenses when you retire then nothing will change besides the fact that you’ll have a whole lot more free time to do all the things that you’ve always wanted to.
Feeling too old you say? Challenge yourself to do something that “old people” shouldn’t be doing and see how exciting it is! Good planning can lead to great retirement years!