Employee benefits insight

Retirement planning and longevity risk

Planning for retirement can be a daunting experience – whether early or later on in your career. The good news is that you don’t have to do it alone or feel overwhelmed by the complexities associated with financial products.

Making the most of your pre-retirement options

Many employers offer a company pension or provident fund, and can provide employees with access to counsellors who can assist in making informed decisions. Of course, you can also speak to a qualified financial adviser who can guide and assist you in making appropriate choices to help you meet your retirement goals.

Retirement planning entails making provision for the income you will require to sustain your desired standard of living after you retire. This income will need to sustain you (and potentially your spouse and/or dependants) until your passing. The ideal replacement ratio¹ is generally accepted to be around 75% of your final working salary, and while many struggle to retire comfortably (only around 6% as calculated by National Treasury), there are measures you can put in place to achieve this outcome. Proper retirement planning is essential, as the income you receive will not only need to sustain you, but also counter the effects of inflation over time.

The ultimate retirement goal is to attain a comfortable standard of living after retirement relative to your standard of living before retirement. One can view retirement planning as a process of putting measurable plans in place (which may change throughout the different stages of your life) to attain your retirement goals.

Making the most of your retirement savings may involve, but is not limited to:

• Selecting the most appropriate and cost-efficient investment product (such as membership of your employer’s pension/provident fund or a retirement annuity, or opting for a voluntary savings vehicle to supplement your retirement income).
• Understanding the impact of fees on your retirement fund value over a long-term investment horizon.
• Understanding your risk/return profile. More aggressive growth assets are ideal the younger you are, and there is typically a transition towards a more conservative strategy the closer you get to retirement.
• Saving as much as possible. Ideally, the percentage of your salary that you should contribute towards retirement savings² is:

     - 24% if you start when you are 35

     - 43% if you start when you are 45

     - 60% if you start when you are 50.

• Starting to save as early as possible. On average, people have a 30- to 40-year ‘window of opportunity’ (i.e. their working career), during which they can take advantage of the wonders of compound interest.
• Avoiding withdrawing funds from a pension/provident fund when changing employers and rather transferring these funds into a pension preservation fund or provident preservation fund.

Understanding investment risk and the importance of diversification

Investment risk can be defined as the probability or likelihood of the occurrence of losses relative to the expected return on any particular investment.³ While we don’t have a crystal ball, and cannot predict market or investment returns over time, the best ally you have on your side is diversification. Diversification helps prevent overexposure to any one particular asset, which helps reduce risk and volatility in your investment returns. As the saying goes, “Don’t put all your eggs in one basket.”

Longevity risk

Longevity risk refers to the risk of outliving your savings, and is one of the biggest risks facing retirees. Recent research has highlighted that the life expectancy of individuals is increasing and, for a variety of reasons (including medical advancements and a greater focus on healthy living), people are living longer today than they were 50 years ago. This means that retirees may face a risk of their life expectancy exceeding the years they have savings available to draw an income from.

The data doesn’t lie

Recent data compiled by the Organisation for Economic Co-operation and Development (OECD) indicates that the average life expectancies for developed economies are increasing. For example, in the United States and United Kingdom, average life expectancies are:

• 18.2 and 18.8 years respectively for a 65-year-old male, and
• 20.8 and 21.1 years respectively for a 65-year-old female.

Conclusion

Research indicates that on average you are likely to live to age 85 or older. It is therefore crucial that you have an adequate retirement plan that is frequently reviewed to mitigate the effects of longevity risk. Speak to your financial adviser to ensure that suitable products form part of your financial plan to mitigate this risk.

1. Replacement ratio is a person’s gross income after retirement, divided by their gross income
before retirement.
2. Source: PSG Wealth. Assumptions: Member retires at 65, saves 15% of annual salary per
year; investment returns average 10% per year; salary increases at 6.5% per year.
3. The Economic Times