A widely used rule of thumb suggests that retirees need roughly 75% of their final salary as an income in retirement, but blindly directing your financial planning at this figure could be problematic.
A widely used rule of thumb suggests that retirees need roughly 75% of their final salary as an income in retirement, but blindly directing your financial planning at this figure could be problematic.
Dave Johnson, company secretary at Sygnia, argues that the rationale for the 75% figure is based on the assumption that three key expenses would fall away in retirement:
The monthly contribution to the retirement scheme
The monthly bond repayments on the primary residence (presumably)
Expenses related to work (transport costs, a working wardrobe etc.)
These expenses would account for about 25% of the salary.
However, every individual’s circumstances are unique and therefore the figure should rather be calculated based on personal considerations.
Johnson says any significant outstanding debt would likely require targeting a higher figure. Quite a number of people do reach retirement age with outstanding debt on their home loans.
One should also consider that in most cases the 75% figure is based on a pensionable salary, but many employers structure income packages to include bonus payments and other benefits that do not form part of the pensionable salary. Thus these individuals have a much higher income before retirement and targeting 75% of only the pensionable salary may not be adequate, he says.
Johnson says the impact of medical expenses in retirement is often underestimated. While medical aids would generally cover significant medical expenses, increasingly out-of-hospital expenses have to be funded by pensioners themselves.
“The good news is that advances in medical care can prolong your life and improve its quality. But it also means you could outlive your savings.”
Johnson points out that people who reach retirement age today could easily be living off a pension for another 30 years.
Another key consideration is the imagined retirement lifestyle. Many people dream of travelling when they retire but this will likely require targeting a higher income in retirement.
“Even those with less glamorous plans need to appreciate that filling the days often comes at a cost, whatever the pastime is.”
For a number of people expenses in retirement may actually be higher than while they were working, because they want to pursue dreams and hobbies they did not have time for prior to retirement.
Johnson points out that the impact of inflation is often underestimated.
“Once you have retired there are no promotional increases to boost your inflation-related salary increases.”
While a pension will generally be adjusted in line with inflation, quite a few expenses may increase ahead of inflation, including medical costs, rates, electricity and possibly also fuel expenses.
Johnson says if one assumes that inflation is 5%, an employee retires at the age of 65 on 75% of his “deemed salary” and his pension increases in line with inflation, the “deemed salary” will need to increase at 7% (CPI plus 2 percentage points) to match rising costs.
By the time the pensioner turns 80, his pension will only be 56.5% of his “deemed salary”.
“To allow for expenses increasing at rates in excess of inflation, you probably need to start well in excess of 75%.”
The difference between the official inflation figure and the individual’s unique inflation number could be a real problem 30 years down the track, he says.