When you think about retirement, you probably envision white sand beaches, flip flops and drinks with umbrellas. Or at the very least, not having to wake up to clock in at 9 a.m.
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But the fantasy is only a small part of the retirement equation. Much of retirement planning is a numbers game. And to have enough money to support your post-work fantasies, you’ve got to have a plan.
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Here’s how to financially plan for retirement.
How much do I need to retire?
When preparing for any financial goal, it’s easiest to start with the end in mind. With some things, like house or car down payments, the number is somewhat easy to peg.
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But funding decades of fun? It’s harder to figure out any one number for that. Here are a couple of common (and easy) ways to get started.
The 80% rule
If the prospect of tallying each cost and expense you’ll incur in your Club Med years is intimidating, fall back on this old standard. For years, experts have said that we’ll probably want between 70 and 80 percent of our pre-retirement income in retirement.
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Why not all of our current income? Well, this rule of thumb relies on a few assumptions, namely that your expenses will be considerably less in your golden years than they are currently. Later in life, you probably won’t be paying for childcare or university, and you may have finished paying off your mortgage or other large debts. That said, if those situations don’t apply to you, you may require more of your income in retirement and may want to up your percentage.
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To calculate how much you’d need in retirement, then, you’d take 70 or 80 percent of your current income and multiply it by at least 20, the average amount of years people live after they retire.
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So, if you earn R50,000 today, you’d want to have at least R700,000 to R800,000 to draw on in your retirement.
Multiply current spending by 25
Rather than focusing on your current salary, some financial advisors encourage clients to hone in on their spending. If you currently spend R300,000 a year, then, you’d want to have at least R7,500,000 in retirement.
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While 25 might seem like an arbitrary number, it’s grounded in another retirement planning rule of thumb: the 4 percent rule.
The 4 percent rule is a common estimate for how much someone can withdraw from an investment portfolio without touching the principal. That’s important because the principal, or the base amount of money you have when you retire, is what will generate most of the returns you’ll rely on without a job for income.
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We multiply expenses by 25 because that’s the fastest way to calculate the value you need to end up with to make an annual withdrawal equal to your current expenses. If you have R7,500,000 in retirement savings, for instance, a R300,000 withdrawal is equivalent to 4 percent of your total.
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The 4 percent rule operates on one big assumption, though: Over the long term, it assumes an investment portfolio will earn at least 4 percent annual returns. While that’s very reasonable for an JSE index fund, which historically earns 7 percent each year on average when adjusted for inflation, chances are your entire portfolio won’t be in shares when you retire.
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You’ll probably have more bonds and bond funds, which offer more stability in value but lesser average returns. That means a more conservative retirement portfolio with a greater percentage of bonds may not provide the level of returns necessary to maintain 4 percent withdrawals over your retirement.
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If you’re concerned about investment earnings not reaching at least a 4 percent threshold, you might consider using 3 percent as your base instead. In that case, to get your retirement portfolio value target, you’d multiply your current expenses by 33.33 instead of 20.
How can I fund my retirement?
You’ve estimated what you may need to fund your days at at the beach. Now, how exactly do you do it? Well, there’s another rule of thumb to fall back on.
The 15% rule
Getting to your retirement goals may be as easy as investing 15 percent of each paycheck, according to research from Fidelity. Saving 15 percent will position most of us to have around 70 percent of our income.
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This, of course, relies on a couple of assumptions—namely, that you start investing at 25. While that’s not possible for all of us—surveys have found the average age that South Africans actually start investing for retirement is 31—a later start means bumping up that contribution percentage some. If you wait a decade, you’ll probably want to shoot for 20 to 25 percent.
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If those percentages seem daunting, remember that even small amounts add up over time. A 1 percent increase in your 20s could add up to a 3 percent greater retirement fund, according to Fidelity’s research. And luckily, when it comes to paying for retirement, you aren’t in it alone.
The bottom line
Planning for retirement expenses doesn’t have to be time consuming or exhausting. General guidelines provide a framework to start saving for the boss-free chapter of your life. With the right investment accounts and contribution rates, you can reach your retirement goals stress-free.
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Investing involves risk including loss of principal. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
