An industry measure of whether your retirement savings will be able to sustain you comfortably is the “replacement ratio” (RR). This is the ratio, expressed as a percentage, of the monthly income your projected retirement savings will provide divided by your projected final salary. Financial advisers typically work to an RR of 75%.
To calculate your personal RR based on your current income and spending, add up your current monthly household expenses. If you’re paying off a mortgage bond and other debts, subtract those amounts because, all going well, you will probably have paid these off by your 60s. Subtract expenses for kids if you have them, such as for clothing and schooling, because presumably they will be self-sufficient by then. But there are also expenses you’ll need to factor in: a bigger portion of your spending will go towards health care and you’re likely to spend more on leisure activities.
Now divide that amount by your current salary, after tax but before your retirement fund deduction (you won’t be paying this in retirement) and multiply by 100 to get a percentage.
Retirement fund benefit statements typically reflect your projected RR at your current level of saving. You can then compare this number with your personal RR to indicate whether you are on track to retire comfortably or not.
Theory versus reality
Sanlam recently issued a report quoting Kanyisa Mkhize, CEO of Sanlam Corporate, stating that, according to its internal member data, most South Africans would need to carry on working until age 80 before they could afford to retire. This was based on the average expected RR of the 300 000 members of the Sanlam Umbrella Fund, which was about 25%. In other words, if they continued at their current rate of saving – with certain inflation, salary escalation and investment return assumptions – when they reached retirement they would receive a pension income of only a quarter of their final salary
In response to questions from Honest Money, Mkhize delved into more details. “The average member, based on our data, is 40.4 years old. These members are contributing an average total gross contribution rate of 12.1% of their salary to their retirement fund, with approximately 2% allocated towards fund costs (including administration, consulting, and group risk cover) leaving a net contribution rate of around 10%. On average, members have been contributing to the fund for 5.8 years, with pensionable service reflecting this period,” she said.
On whether the statistics may be weighted towards younger members, Mkhize said: “While it may seem that younger members would skew the RR, younger members, in fact, tend to have higher RRs. This is because the projections assume that all members continue contributing to their retirement savings until they reach the normal retirement age (65). Younger members have more time to accumulate savings and benefit from the power of compounding, leading to higher expected RRs.
“On the other hand, older members, many of whom have not preserved their retirement savings or had interruptions in their contributions, tend to have much lower RRs. This results in a lower overall average RR, despite the fact that younger members, who have higher savings potential, are contributing to the overall figure.”
Mkhize said employers can improve the retirement prospects of their employees in various ways, including:
• Automatically escalating employee contribution rates to align with salary increases;
• Matching employee contributions with contributions of their own; and
• Providing employees with access to financial advice, planning tools and financial education.
