A replacement ratio is the ratio of the income you receive from your pension once retired, to the salary you were receiving just before retirement.

For example, if your pensionable salary just before you retire is R10 000 per month and your replacement ratio is 80%, you might expect to receive R8 000 per month in retirement.

It is generally accepted that replacement ratios of 70% or more should be adequate for the average person. This takes into account that your lifestyle and spending patterns change as you get older. For example, you generally have fewer dependants and lower daily travelling costs, although healthcare expenses may increase.

Calculating your replacement ratio can be a very important exercise when planning for your retirement, but this requires using many assumptions about the future, which we know is full of uncertainties.

A better approach may be to focus less on the ratio itself, and more on the factors that have the biggest impact on improving the ratio. It is always helpful to chat to your financial adviser about your individual situation, but here are a few pointers that could help.

• Boost the number of years you contribute to and invest for retirement

Start investing towards your retirement as early as you can and if it’s too late for that, consider retiring later – those additional years of contributions are exposed to compounding investment returns, which means they will have a significant impact on the amount of retirement income you are able to purchase.

In addition, if you purchase a life annuity it should get cheaper as you get older.

• Increase your contribution rate

If you have discretion over the percentage of your salary that you contribute to a retirement vehicle each month, consider increasing it by as much as you can.

The sacrifice in take-home pay now will ultimately be insignificant when compared to the potential benefits of the extra income at retirement. For example, contributing an extra 3% of your salary each month could buy you an extra 15% per month in retirement.

• Make additional voluntary contributions or have other external investments

In addition to your monthly contributions, your retirement vehicle may allow you to make periodic lump sum contributions to boost your fund credit. There are also tax benefits to encourage you to invest within a retirement vehicle.

However, if this is not an option for you, then you could also consider investing in assets that don’t fall under a retirement vehicle wrapper. These would not see the tax benefits, but may allow you to invest with more freedom to suit your situation.

• Beware of costs

There are many factors you need to consider when making an investment decision, costs being one of them. A difference of only 1% in charges over your working life could mean a difference of as much as 30% in the money you have at retirement, given the compounding effect over a long-term horizon.

• Preserve your savings

This is a particular problem in South Africa, with its fairly mobile labour force and a younger generation who tend to job hop. When leaving a job where pension or provident fund contributions have been made, it is extremely important to preserve those savings in a retirement vehicle like a preservation fund instead of spending the money.

• Reduce your lump sum withdrawal

At retirement, the less you take out as a lump sum, the more you will be able to spend on buying yourself a pension-providing product such as a guaranteed annuity. This will be further encouraged by regulation in the future, where pension fund-type structures will become more prominent and limit the lump sum amount available at retirement in favour of a larger annuity purchase.

• Consider your goal

Bear in mind that you are actually investing with the goal of receiving a decent income from the time you retire until you die. This implies that you shouldn’t see your retirement date as the end point of your investment horizon, but rather that there should be a smooth transition from the asset mix you have before retirement to the one you have after that.

The retirement industry is changing rapidly in South Africa and abroad, where the general trend is that the person on the street is having to take more responsibility for his or her own retirement.

Fortunately, both Treasury and the industry itself are working together to help improve financial awareness and encourage South Africans to improve the way they save for retirement.

Nevertheless, it is extremely important to take responsibility for educating yourself, and to seek professional advice tailored to your own situation.

Sean Smith
Liability-Driven Investment Services

More information?

For more information, please contact RisCura Consulting via email or on +27 (0) 21 673 6999. This article appeared on Fin24.

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