Beatles – Sgt Pepper Album
If we are no longer preparing for retirement, what should we be preparing for and why?
Looking at the evidence its easy to see that because we are living longer we should be retiring later. This is so that we have more time to accumulate money for a longer retirement. Bismarck and all that. But the ultimate issue is to define what retirement is? Or perhaps more pointedly, what a financially independent retirement is?
Until you have this definition in the bag the rest is a discussion of hypotheticals. So here’s a shot at a description: “When you can stop working for the money and the money works for you.” What is so difficult about that?
Quite a lot as it turns out. If the “figures” are to be believed anywhere between five and twenty six percent of it fund members are financially independent when they retire. The rest are doomed, in varying proportions, to need help from their friends and families, to work until they drop or to suffer a terrible, demeaning loss of their living standards.
Why is this?
- First of all there is an underestimated and tenaciously held belief that your pension (or provident) fund alone, will provide you with enough money to retire on when you reach your employer’s retirement age!
- No-one is educated to understand the mechanics of saving and investing enough for retirement, which leads them to making primary errors:
- They think saving for retirement can be left to the last minute;
- They don’t understand the need to protect pension fund benefits when they change jobs;
- They don’t understand that the responsibility for having enough put by is theirs and theirs alone;
- They have a belief in the ability of investment fund managers to deliver miraculous investment growth;
- Few people can monitor their progress to retirement other than anecdotally; and
- Not enough people take inflation seriously enough nor do many of their service providers.
The Christopher Columbus Management Philosophy has some similarities with many people’s retirement planning:
- You don’t know where you are going;
- You don’t know how to get there; and,
- You won’t know when you get there.
Is it a wonder then that the number of people retiring with financial independence at a formal retirement date is so low?
Unless inflation is properly factored in to plans most results will be a matter of luck, either good or bad. Most employees don’t have a choice about retiring from their employer’s service. They are politely shown the door on the appointed day. Most think that they leave with only the money from their retirement fund as well as their personal savings and investments. This is undoubtedly true but they forget a major asset of great value i.e. the skills they have learnt over their long working lives.
If their financial planning can predict a shortfall at nominal retirement date, and do so in advance, they can plan a second career to which they can take their hard-earned skills. This is a sensible way of extending their working lives which gives both financial security and a great deal of emotional comfort.
Anthony Asher, an Australian actuary, spoke several years ago about the financial benefits of working longer. He said that if at the time of retirement you can preserve your financial retirement provision and continue to contribute you increase your potential pension by ten percentage points a year.
What then is the solution?
The solution, I think is that everyone should plan for a particular retirement date. However they must bear the following fateful words in mind: “Life is what happens to us while we are making other plans.” They come from the American cartoonist and author Allan Saunders (Not John Lennon).
Planning for a particular retirement date or age provides a framework within which to work. It’s a logical and easily understood target date. Individuals must measure progress regularly to see how they are doing. If they are falling behind they need to consider both additional savings and a longer working life.
Planning assumptions are crucial or what looks like success may not be quite what it seems. To aim at a certain amount of money for retirement an assumption must be made as to the income that such capital will provide. For example an income of R500 000 per year will require initial capital of R10 000 000 if income from capital is assumed to be 5 percent per year. If an assumption is made that income can be obtained from capital at 7.5 percent per year the capital required is R6 666 666.
So it looks as though jacking up the assumed rate at which capital produces income is a quick easy way to make saving for retirement a whole lot easier. Not at all and it places a burden on whoever is investing that capital because the higher the income drawn from capital the higher the investment returns must be.
If investments only need to replace the income drawn then that would be a little easier but if you act as though that is the case and earn say the 7.5 percent back you will only have the capital value that you had at the beginning of the previous year. This means that if earnings only match the income level your income will not rise to cope with inflation. If you withdraw income at a higher rate you will start to dig into your capital and that is the first step down a slippery slope.
If you draw an income from your retirement capital at say 7.5 percent a year it would then make sense not only to replace the income that you drew but also to provide for inflation so you probably need to add the official inflation rate to that required earning level. That (if you truly believe inflation is 6 percent per year) means you must earn 13.5% on your capital which is not nearly as easy. If we add an Effective Annual Cost percentage (annual investment costs) of say 2 percent per year to that it means needing to earn an annual 15.5 percent growth (if you can.)
Post retirement earning is a neat way to protect capital because it helps with keeping capital growing and providing individuals with some very practical goals in life.
In closing then I cannot see any point in ditching existing retirement dates as initial targets. Due to the lack of success by most people in reaching even those adequately I would suggest having a secondary target of at least five years after your formal retirement date. This makes a sensible plan and provides a source of hope for the future as many retirees fear passing into a sort of limbo with nothing useful to do. And if nothing else working to keep your living standard up to the mark is useful.
Robert Louis Stevenson Quote:
Sooner or later everyone sits down to a banquet of consequences.
30th May 2017
Dave Crawford CFP®
Proprietor: Planning Retirement – specialists in retirement fund member education only