The chances are, if you’re older than fifty, you’re probably thinking about planning for your retirement right?
If you’re only just making ends meet now, how will things be for you when you retire?
Questions you may ask yourself before retirement
- What if my retirement nest egg isn’t large enough?
- Will I be able to keep working after I reach retirement age?
- What sort of income will my million Rand pension fund buy me?
- What if I run out of money? Who will look after me?
The issue most of us face right now is this:
- We spend our working years being taken care of by our employers. They pay us a salary, which if we don’t like, we can resign, but more importantly, they force us to save for retirement.
- Then, at age 65, the tables turn, and from then on, it’s up to you to take care of yourself
It’s therefore crucial that you plan for this day.
So what is retirement planning all about?
Every person reading this, will at some point, need a financial plan.
Basically, a retirement plan looks at two timeframes:
- The time between now and retirement, and
- The time from retirement till death
Let’s reverse the two scenarios and look at each one in more detail.
From retirement till death
- The first step is to determine the monthly income you will need at retirement.
In other words, a current income need must be calculated, and this needs to be projected forward taking the rising cost of living into account.
So, while R10,000 a month might sound fine if you were retiring today, twenty years from now it most definitely won’t.
- The second step is to determine whether any debts will need to be settled at retirement.
Ideally, no-one wants to retire with debt. It does however happen, that the purchase of a brand-new vehicle needs to be factored into the retirement plan.
- The third step is to determine life expectancy.
Usually two people – a husband and a wife – are involved, and we need to plan for an income over their combined life expectancy.
On average, a 65 year old male will live a further 12 years while a 65 year old female will live another 15 years. The income needed must be projected over the full 15 years.
- The fourth step is to project the expected rise in the cost of living over that combined life expectancy.
That’s because we want our income to increase every year in line with the cost of living.
- The fifth, and final step, is to project an anticipated annual return on this investment.
If we worked off a zero-percentage return on this investment, we would need a massive lump sum to provide the required income. The higher the expected investment return, the smaller the lump sum needed to provide that income.
Using these five factors, we can then determine the amount of capital required at retirement to meet the income need. Financial planners use complex software programs to prepare these calculations for you.
Quite clearly this is not something you want to find out at retirement. By then it’s too late to do anything about it.
Now that we know how much we need, let’s look at how we’re going to get there.
Between now and retirement
Let’s look at a fictitious calculation based on the above. You’ve worked out that at retirement you will need R1 million to provide:
- R10,000 a month
- Increasing by 8% every year, and
- Lasting for 15 years
We must now figure out how you’re going to get the R1 million by the time you retire at 65.
- The first thing we need to do is include the value of your pension or provident fund.
Not only must we include the value of the lump sum you have available, but we must also project your future monthly contributions towards this retirement fund.
- The second thing we need to do is include the value of all your existing investments.
Well, at least those which are going to be used for retirement (After all, it doesn’t help including all your educational savings plans!).
Once again, we need to project the monthly contributions to these investments.
- Thirdly, we need to project the anticipated monthly return on all these investments and provident funds between now and retirement.
As already mentioned, the higher the percentage annual return we achieve, the less the amount needed to invest.
- Fourthly, we need to calculate the monthly income need in today’s money (Present value) and project that into an amount needed at retirement (Future value).
While R10,000 a month might sound comfortable today, R10,000 a month twenty years from now isn’t. Your R10,000 today might be the equivalent of R20,000 then.
- Finally, we need to determine the investment time frame between now and retirement.
The longer this time frame, the more risk you can absorb when investing. Not only that, but you can invest far less than someone who starts saving a lot later.
Using these five factors we can determine whether you’re on track to meet your retirement objective:
- By deducting the post retirement need
- from the pre-retirement savings,
- we can calculate the shortfall, and
- Determine what investment needs to be made to address the shortfall
Retirement planning is crucial for all of us and the sooner you start the better. Twenty years out from retirement you can still make course corrections, but five years out there’s not much you can do.
These calculations sound simple enough but try doing them yourself. The good news is that you don’t need to – that’s why financial advisors exist. Unless you have some sort of financial background, you’re going to struggle so why even bother?
Meet with an advisor and test him or her – don’t worry, you don’t have to buy anything if you don’t want to. Test to see whether they will be with you for the long haul. If you’re not comfortable with them, then find another.
But don’t wait until retirement before finding a financial advisor whom you can trust.
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