This week, I had an interesting conversation with Lourens Coetzee of investment company Marriott about the reality that the concept of retirement may no longer be possible.
As we start to live longer, the average 40-year-old is expected to live to 90, so we have to fund even more years with our retirement income. At the same time, market returns and interest rates are lower, which means we have to save more money to have the same financial outcome we would have had in better market conditions.
The reality is that very few people save sufficiently for retirement as it is, and even if they do, they may find that what was enough 10 years ago will fall far short today.
When you retire, one of the options is to purchase a guaranteed life annuity that will pay you an income until you die.
While the fall in South Africa’s interest rates over the past two decades has been good for borrowers, it has been devastating for retirees as guaranteed annuities are a function of interest rates.
In retrospect, the smartest move a retiree in 1998 could make was to buy a life annuity and lock into the record high interest rate of 23%.
In that year, annuity rates would have provided an income of about R16 000, increasing each year, for every R1 million invested. So, if you retired with R2 million, you would have an income of about R30 000 a month.
Fast-forward to 2018, where interest rates are at 6.75% – a retiree today would only receive an income of about R6 000 per R1 million. To put it another way, you would have to have R5 million to generate the same income as you could have retired on with R2 million at an interest rate of 23%.
This massive reduction in the income generated from life annuities has seen many pensioners rather opt for a living annuity, which is invested in a market-linked portfolio. With this annuity, the retiree draws down an income of between 2.5% to 17.5% of the capital a year.
Again, this strategy worked in the early 2000s, when the market was in a bull run and the acceptable drawdown rate was 7% of your capital as income.
Because market returns were averaging 15%, a drawdown of only 7% meant you were leaving money to grow that would ensure an income that kept up with inflation.
However, markets go through bear markets and bull markets, either of which can significantly affect a retiree’s potential income.
Marriott’s research shows that the amount you can afford to drawdown is significantly affected by the market returns in the first 10 years of retirement.
There were times when market performance was so significant, retirees could start with a withdrawal rate of 13% and their capital would still last for 30 years. In other words, you would receive R10 833 a month for every R1 million invested.
However, if there is weak market performance during the first three to four years of your retirement, you’ll have to draw a lower income and it is likely that you will run out of capital.
As Coetzee says, while this may seem obvious, the problem is that future returns are difficult to predict.
We have no idea when we retire what the market performance will be over the following few years, which means that any retiree has to take a conservative approach to drawdowns to ensure they do not run out of capital.
While a drawdown rate of 6% is the most common among members of living annuities, Marriott’s research found that, based on historic market returns, a retiree would run out of capital if they selected a 6% drawdown rate about 50% of the time.
It is now commonly agreed that, when it comes to retirement planning, you need to assume that the maximum you can afford to drawdown is about 4%. You may be fortunate and have great market returns in the years after you retire, but that would just be a bonus and would mean that you could increase your drawdown in later years.
What this conservative approach means is that you have to have even more capital to live on a drawdown rate of 4% compared with 7%.
A R1 million investment at a drawdown rate of 7% would have given you an income of R5 833 a month, but at a drawdown rate of 4%, it would only provide you with R3 300 – a drop of 40%. Again, the only solution to this is to have more money at retirement.
Coetzee believes that even the rate of 4% a year is not realistic because fees still need to be taken into account. If you are paying 2% a year in fees to a financial adviser and product provider, in reality, you’ll only get an income from 2% of your capital.
SO, WHAT ARE YOUR OPTIONS?
1. The bottom line is that you cannot keep cashing in your retirement fund. Every time you cash in, you increase the chance that you will not be able to afford to retire on your pension.
2. Stop borrowing and make paying off debt part of your retirement strategy.
You cannot afford to get to retirement age and owe money on a house, car or credit card.
Aim to stop taking on new credit by the age of 45 – if you have a 20-year bond at the age of 45, it will most likely be paid off by the time you’re 65.
3. You need to be realistic about your retirement age. Retiring at 55 or even 60 is a pipe dream. It is more likely that you will have to find a way to earn an income at least until the age of 65 or even 70.
4. Start a second career or a side business. Second careers have become a big trend in the US, in which people older than 55 represent the largest number of new employment numbers.
Your retirement strategy will be less about putting up your feet and more about finding something you really enjoy doing and working out a way to make money from it.
Income from property is another way to boost your retirement income.
The longer you can leave your retirement funds to grow, the higher your income will be. Not only has the money had a longer time to benefit from compound growth, but you’ll also need to fund fewer years of retirement.