CAPE TOWNCurrently any South African can put up to 15% of their non-pensionable taxable income into a retirement annuity (RA) and claim these contributions as tax deductible. For many people this has created the impression that 15% is some sort of magical number, and that if you can save at that rate you will be set when retirement comes around.

The truth, however, is far more complicated. Although trying to calculate how much you really need to put away requires making a lot of assumptions about the future, we can make some informed guesses about what you will need when your retirement date comes around.

Consider this example: A newly graduated accountant, let’s call her Jane, starts working today at a monthly salary of R20 000. If she enjoys an annual increase of 8% for the next 40 years, she will be earning just over R4.8 million per year when she retires.

In order to fully replace that income at a starting withdrawal rate of 5%, Jane would need to have accumulated capital of R96.5 million by 2055.

That number is likely to terrify anyone who has just received their first pay check, but this is the reality. The compounding of inflation over the next 40 years means that anyone entering the workforce now has to plan with a retirement capital target in mind of multiple millions.

The good news is that these numbers are attainable. If you start early enough, save at an appropriate rate and choose your investments wisely, 40 years is enough to get where you need to be. For most people, however, it will require saving more than you think you need to.

To illustrate this, let us return to our example and assume that Jane diligently puts away 15% of her salary every month into an RA for the next 40 years. If she earned an annual return of 10%, she would have accumulated R49 million.

That might sound good in today’s money, but it’s barely 50% of the R96.5 million she would need to fully replace her salary. In other words, as soon as she entered retirement, she would have to settle for an income half of what she was earning immediately before she put away her spreadsheets for the last time.

If however Jane invested more successfully and managed to earn an annual return of 12% on her money, she would have R79.5 million. That is still short of her target, but could at least give her a replacement ratio of 82%.

These numbers reveal two things. The most obvious is how significant a small increase in annual returns can make when these are compounded. The difference between 10% and 12% might not sound like much, but over 40 years, it is worth 60% more.

The second is that only saving 15% is unlikely to be enough to reach your retirement goal. Even if you start early and even if your returns are good, you will probably come up short.

In order to reach the R96.5 million she requires, Jane will need to save a little over 18% of her salary every month, and earn an annual return of 12%. If she manages to do that for 40 years, she can retire happy.

The problem for many people, however, is that they are not like Jane. They don’t start saving from their first pay check, because retirement seems an awfully long way away.

That brings us to a second example: Jane has a classmate, who we shall call John. He too starts working today at the same salary of R20 000 per month, but it is five years before he makes his first RA contribution.

If he then saves 15% of his salary every month and earns a healthy 12% every year, he will only reach R61 million. That is just 63% of what he needs.

Even if he saves 20% every month and secures a return of 12%, he would still only reach 83% of the R96.5 million target. And this is an equation that gets more and more challenging the longer he delays.

If John takes ten years before he does anything about his retirement, he will need to save 25% of his salary just to get to R76 million, or 79% of his target. That might sound manageable, but the chances are that by then John will have children in school, a home loan to pay off, extensive fixed expenses, and saving will be even harder than it would have been when he first started working.

And if all of these things prevent him from saving for another five years, what he will then need to put away becomes even more demanding. Even if he saved 35% of his salary every month from that point, he would only reach R73 million, or 75% of his retirement target.

This clearly illustrates how the longer you delay your retirement saving, the more difficult it becomes to attain your goal. It also shows that saving 15% is very unlikely to be enough.

Thankfully retirement reform in South Africa will soon be raising the tax exemption for retirement savings to 27.5% of taxable income. Hopefully that will encourage South Africans to save a lot more, because unfortunately many are likely to be caught short.

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