Have you ever wondered whether you are saving enough for retirement? It’s a question to which there are many possible answers because there are many variables. We have developed an application to make this question easier to answer, not just once but throughout your life until you retire.
For starters, how much is “enough”? We believe that “enough” in retirement means that you can afford a standard of living in retirement that is the same as, or close to, the one you have now. This means that you need to know what your living standard is now. We define “living standard” as INCOME AFTER SAVINGS AND TAX HAVE BEEN DEDUCTED
Whatever is left is what you spend to live on and is thus your living standard.
In theory you could just project the value of your living standard up to your retirement date and then work out how much capital you would need to provide at that point in the future.
It’s difficult because we have no idea what inflation rates will be in the future. This makes any projections into the future using assumed inflation rates suspect and likely to create disappointment. If, for example, we project amounts over 20 years at inflation rates of both 6 and 7 percent per year, we find a difference in the nominal values at the end of the period of around 20 percent. That’s a big difference!
We thought we would try something different. We looked at finding a relationship to use to measure progress. And we found one that works very well indeed.
Retirement Readiness Score: Method
We show the after-tax income that you would have if you retired today, as a percentage of your living standard. This relationship is your Retirement Readiness Score and it shows us how adequate your retirement provision is right now!
If, for example, your instant “retirement” income is R15 543 a month and your living standard is R37 995 a month, your Retirement Readiness Score is 40.91 percent. 41 percent near as dammit! Now you know where you stand.
What remains is for you to increase that 41 percent score to 100 percent in the years left until you retire.
If the older member of a couple is 55 years old, and they intend to retire when he (or she) reaches 65 they will have 10 years in which to raise that score from 41 percent to 100 percent.
The Measure sets out what those scores should be each year for the 10 remaining years to enable annual progress monitoring. This allows people to see if they are on track for “enough”.
If they are behind, remedial action can be taken. With this methodology problems can be identified very early on, allowing for prompt action.
A by-product of producing the goals is that the percentage by which they must increase every year is produced. This is also the real return that someone needs to earn on their capital and existing saving if they are to make their targets. You therefore have a series of clear annual goals set out as retirement readiness scores.
Real returns are investment returns from which the inflation rate and costs have been deducted. So, if we are know what the real return must be, we can work out what the overall annual average investment return should be for the years between now and retiring. In this case the real return needed is 9.35 percent per annum. If we add inflation at 6 percent per year and costs of 2 percent per year their average overall investment return target needs to be 17.35 percent per year for the next 10 years. That’s a big ask and it means that they aren’t saving enough.
As a rule of thumb, we estimate that if your real return is 4.0 percent per year or higher, you are not saving enough. (A real return of 4 percent plus 2 percent for costs and another 6 percent for inflation means that an overall investment return of 12 percent per annum would be needed.) This means that you need to save more.
An amazing thing happens when you save more. Your living standard goes down because you have saved more and your Retirement Readiness Score goes up. When your Retirement Readiness Score gets higher it brings the real return that is needed down which in turn lowers the investment returns required to get to your target.
Using our software, you can see from regular annual assessments whether you are meeting your targets. If you review your situation every year, or even more frequently, you develop a very clear idea of your retirement status.
The measure provides a comprehensive short report which summarises the findings mentioned above. It also gives you two more important pieces of information.
The first piece of information is the amount of extra tax-deductible contributions that you may make to retirement funds such as pension, provident and retirement annuities in this tax year. Income tax legislation now allows you to make tax deductible contributions of up to 27.5 percent of your remuneration.
Because of the way retirement funds rules are structured it is not always easy to work out exactly how much extra you may invest in this way. The total of such tax-deductible contributions is limited to R350 000 every tax year.
The second piece of information is your personal inflation rate. This is done by comparing one year’s living standard with that of the next. That difference is your personal inflation rate. Because inflation is such a burden for retired people, knowing what it actually is now gives you a chance to do something about it.
You can test proposed future actions using the what-if facility. If you want to see what happens when you increase contributions to saving, you may do so before you commit.
You can also model the effect that working for several extra years may have on your retirement adequacy. You can change your goal from the 100 percent that we talk about to say 80 percent and see from the lower real return whether you are still comfortable with your existing investments.
You will have access to the site for 12 months for R200 plus VAT. This is renewable annually. You may do any modelling that you want to and print as many reports as you like.
Below is an example of a graph and a table showing targets. These also appear in the report