The “million-dollar question” is how much money do I need to retire? The starting point in answering the question, is to determine how much income you need in retirement? However, this is often underestimated as unexpected expenses occur, such as medical bills, and asset maintenance and replacement, and often, taxation is not properly accounted for.
The “rule of thumb” is to draw an annual income of 5% or less of your total savings, which should last 30 years if your savings grow at 4% above inflation, around 9%. This does require taking on risk, which needs patience and trust in your investment strategy. In the current, uncertain environment, retirees have become far more risk averse, resulting in investors taking on too little risk and jeopardizing their long-term growth goals and income levels.
Understanding the impact of inflation
As inflation increases the cost of living, one needs to plan for a return above inflation and draw an income that can increase to cover your growing expenses. Therefore, determining the right return above inflation on your investments and the appropriate starting income at retirement are key considerations in your financial plan.
To achieve a return that is higher than inflation after tax, a certain amount of risk needs to be included in your investment strategy. We discussed the need for risk in a previous newsletter, One’s Biggest Investment Risk is Not Taking any Risk . The higher the targeted return, the more risk is required for growth.
Selecting the appropriate starting income
When drawing a regular income from your investments, it is important to start with an income that can increase with inflation but does not erode a growing capital base which is necessary to support higher income levels over time. Drawing interest only is not a good starting plan as neither your investment nor your income can adjust with inflation over the longer term.
The table below provides a rough guide as to how long (in years) a R10m investment can last when drawing different starting incomes and achieving different above-inflation returns. The income is assumed to increase by inflation every year and we estimate an average tax rate on income of 15%. This is the tax payable on interest earned and capital gains tax.
|Monthly income on R10m||Annual Drawdown||Long-term Return above inflation|
Achieving an investment return of 4% above inflation requires a moderately conservative investment strategy. This will roughly require 50% equities (risk/growth assets) and 50% interest-bearing assets (bonds/money market). Achieving a higher return would require taking on more risk and would generally be capped at 7% above inflation. This is the long-term average stock market return, which comes with major ups and downs.
Sounds simple, but there is a lot more to consider
Are you invested in the most tax-effective product or combination of products, such as living annuities, endowments, or discretionary investment portfolios? This could result in lower taxes and far more income over time.
Do you have the right investment strategy that takes on the appropriate level of risk to achieve your desired returns?
Be aware that volatile investment markets can lead to fluctuations in your regular income and put pressure on your regular spending habits.
It is also important to consider the possibility of you outliving your “30-year retirement period”. This may sound like a bonus and it is becoming more likely with a far higher percentage aging population, but financially speaking, this is a risk.
Carrying out regular reviews of your retirement plan to ensure your plan is on track and to identify whether any adjustments are needed.
Considering the effectiveness of your estate planning, which can provide important peace of mind for your family or dependents.