Nicolette Dirk, finance writer, Justmoney.co.za
The latest statistics by the National Treasury indicate that only 10% of South Africans are able to retire without financial assistance.
This means that most people cannot afford to retire early. For those who chase early retirement, financial advisors have advocated applying the '4% rule' to ensure that investors have enough to fund their retirement.
Created in 1994, the rule advocates that if you draw 4% of your savings in the first year of your retirement and adjust this income each year by inflation, and then your money would last for at least 30 years.
But while this rule may help some retirees, there are a multitude of other factors that need to be taken into consideration to ensure a successful early retirement says Tracy Jensen, product architect at 10X Investments.
How does the 4% rule work?
The '4% rule' is applicable to retirement products where your money remains invested at retirement and where you take the risk of running out of funds. This is known as a living annuity.
Jensen used the example of a person who has R1million at retirement. This would mean 4% of this is an income of R40 000 per annum.
"According to the rule, in the first year you could draw R40 000. The following year you would draw an income of R40 000 plus inflation and so forth. The rule proposes that you could continue to do this for at least 30 years before you risk being unable to increase your income with inflation," said Jensen.
Will it work in South Africa?
Jensen said that while the '4% rule' still applies to retirement investing, South Africa is unique in that regulation restricts the income drawn each year from 2.5% to 17.5% of your investment balance.
"As a result, investors could have sufficient money to draw the income they desire but are restricted once they reach the 17.5% cap. Therefore, it is important to include this capitation when testing the rule," said Jensen.
There is much debate regarding the income level that is sustainable so as to mitigate the risk that the money is depleted. Louise Van Der Merwe, financial planner at Wealthup, said that one of the risks you have to consider is whether your portfolio can sustain a 4% withdrawal.
“If you only have a cash investment you will still be eating into your capital. The 4% is a good rule of thumb but many South Africans don’t have enough capital to be able to stick to drawing 4%,” said Van der Merwe.
Start saving well ahead of retirement
According to Jensen you should save as much as they can, for as long as they can. "This should equate to at least 15% of your gross salary over a period of 40 years. In doing so, this should give you an income of approximately 60% of your final salary in retirement," said Jensen.
Jensen said that for those who are within a few years of retirement there is little that can be done to increase a savings balance in order to retire earlier.
"For those who have a while to go before retiring, a good rule of thumb is that for every 10 years earlier you retire, you need about 30% more money on average. If you are saving for 30 years instead of 40 years, you need to increase your savings from 15% to about 25% of your gross salary.
Even though you need 30% more money, your contributions need to increase by more than 30% to take into account the missed investment returns due to a shorter savings period. This assumes you are only paying a fee of 1% pa or less," said Jensen.