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Cape Town - How do you know if you can retire financially secure?
People tend to be overly pessimistic about retirement, says Andrea Bezuidenhout, advice partner at The Wealth Corporation.
She says perhaps this is because people "feel the need to hold on to their savings with a vice-like grip, afraid to invest it in anything “riskier” than a money market portfolio, for fear of it disappearing into the unknown of the financial markets in their twilight years".
"Or maybe the concept and assumed finality of retirement is just too great to comprehend. Therefore, we would rather take a glass-half-full approach to our savings than attempt to understand the opportunities and risks associated with investing in the markets," said Bezuidenhout.
"Your financial adviser is able to help demystify the markets for you, and help you to understand the risks and opportunities of investing, as well as the opportunity cost of delaying investing your savings."
Despite all the attention given to a retirement “number” — or total savings — there are several other variables that have a significant impact on finances in retirement.
If you are either too optimistic or too pessimistic in considering these numbers, it can throw off your retirement calculations by years.
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Bezuidenhout says to be retirement-ready, in addition to your investments, you need to consider:
Your living expenses
This is the area of our finances where you have the most control. People tend to assume that their monthly living expenses will decrease in retirement.
While this may be the case over time, you need to consider the expenses which are likely to increase, such as medical aid.
You may also find yourself wanting to travel more to visit your grandchildren overseas, for instance.
"Before rushing headlong into retirement with great expectations of grandeur on a not-so-grand monthly budget, you need to do a budgeting exercise to distinguish between your needs and your nice-to-haves," said Bezuidenhout.
"As renowned boxer George Foreman states, “The question isn't at what age I want to retire, it's at what income.”
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The rate of inflation
Forget about keeping up with the Joneses. In retirement, it’s all about keeping up with inflation. When you have a static income, it’s important that you adequately cater for the steady increase you can expect in the costs of goods and services.
Medical care and pharmaceutical costs have consistently increased at levels above inflation over the past few years, and this needs to be taken into consideration as well.
When you can no longer rely on that annual bonus or windfall income to get you out of debt or pay an unexpectedly big bill, you need to ensure that you have sufficiently catered for such eventualities.
"For this reason, you should not keep the majority of your retirement savings in money market accounts and the like, as these cannot keep up with the erosive effect of inflation over time," she said.
"The best way to beat inflation is to hold a decent portion of your investments in equities, which have a greater chance of providing you with the necessary returns in the long-term."
With retirement sometimes lasting as long as your working career, you need to take a long term view. Be too cautious in considering inflation in your retirement planning and you can significantly impact on the longevity of your income in years to come.
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The tax rate
"By this, we refer to the amount of tax paid on your total income. While you will be required to pay taxes in retirement, certain concessions in terms of tax thresholds exist. And as you will likely be earning less in retirement than when you were at the peak of your career, you will be in a lower marginal tax bracket than previously," said Bezuidenhout.
In addition, while you were working, you were earning an income from one or two sources that are fully taxable at source according to the income tax provisions.
However, in retirement, your income needs could be constructed from varying investment vehicles with differing tax applications, thereby lowering your effective tax rate substantially, giving you more disposable income on a monthly basis.
Investment returns have a significant impact on your retirement capital, but often this is viewed in isolation.
It is important to remember that in effect, investment returns are one variable which, along with your living expenses, tax rate and inflation ultimately affects the longevity of your retirement capital.
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