How to end up with the right retirement income: Part 2: How much should you contribute?
In part 1 of our series on retirement planning, we introduced the concept of life-staging and discussed the importance of reducing your debt before you retire. In this edition, we look at how much you should be saving towards retirement and how to check if you are on track to reach your financial goals.
At its core, saving towards retirement is a lot like contributing towards an insurance policy. While it may seem like a grudge purchase when you’re younger, the item that you are insuring is your future standard of living, and the event for which you are covered is your retirement. If structured correctly, your retirement savings should be sufficient to place you in the same financial position as the one you enjoyed before retirement. Not having the right cover, or more specifically, not having saved enough for retirement, could mean having to dramatically downgrade your standard of living during your retirement years.
The psychology behind contributing towards retirement is also fairly similar to paying insurance premiums. It’s easy to fall into the trap of thinking that as long as you are contributing towards your retirement that you will be financially covered when the big day comes. But ‘skimping’ on payments may just be providing you with a false sense of security. The reality is that merely contributing towards a retirement fund is not enough; it’s far more important to make sure that you are contributing the right amount from the outset to avoid any nasty surprises down the line.
That said, knowing how much to contribute can be difficult. A recent survey from a leading employee benefits firm suggests that the majority of retirement fund members leave this decision to their employer, with very little understanding of how much they contribute each month. However, research has found that the default contribution amount is often far less than what is required to retain your current standard of living post retirement.
It’s generally recommended that the level of income you receive once you’ve retired should be between 60%-80% of your gross income before retirement (also called your income replacement ratio). This is based on the assumption that up to 40% of your gross income before retirement has been used to pay off debt and other expenses. As discussed in part 1, by the time you retire most of your big debts like your mortgage, car loans, etc. should already be paid off, which means that an income replacement ratio of between 60%-80% should be sufficient for you to retain your current lifestyle.
To check if you are on track to meet the 60%-80% target, a good starting point is to review the value of your current retirement savings and to find out how much you are contributing on a monthly basis. You will also need to determine how many years you have left before retirement and the investment returns you expect to receive over this period. This should give you a good idea of how much money you will have saved up when you retire.
Using a starting salary of R20,000, the table below* provides a good indication of how much you should have saved as a multiple of your salary based on your age. It is based on a number of key assumptions, listed below.
The most efficient way to ‘insure’ your current standard of living at retirement is to start saving early and contribute the right amount from the outset. However, if you have left it late or if you haven’t been contributing enough, there are options available for you to increase your chances of reaching your retirement goals. Whichever position you find yourself in, it’s best to speak with a good independent financial adviser to assist you with planning for retirement.
Prudential offers a range of unit trusts that are designed to help you earn more from your retirement savings. You can use our Retirement Calculator to determine how much you need to contribute monthly so you can retire comfortably. For more information, contact your Financial Adviser or our Client Services Team on 0860 105 775 or at firstname.lastname@example.org
*Based on the following assumptions: You start saving for retirement at 25. You contribute 15% of your salary towards your retirement savings. Your salary grows by 6% inflation each year.. You plan to retire at 60. Your goal is to have an income replacement ratio of 75%. Your retirement savings will need to last for at least 30 years. Your pre-retirement investment returns will grow by 11% annually (inflation plus 5%). Your post-retirement investment returns will grow by 10% annually (inflation plus 4%).