We as Financial Planners receive the following question so often from clients and potential clients that I decided to prepare this article to clarify the matter. There is unfortunately no alternative to these calculations as I have not come across one situation in 31 years of practice where this loss was made up through normal savings over the original period since the decision was made. To this argument, I use standard figures to illustrate.
The details of the client: The client has R500 000 in his/her retirement investment through his/her company retirement fund. He or she is about to leave the existing company, in other words he/she has resigned, is 35 years old and want to retire at age 65.
The client’s question: I want to start a new business, or I have a bond which I want to reduce or settle, or I want to reduce or settle my debt. I will make it up again as I have enough time left to retirement at age 65. This sounds familiar, doesn’t it.
Further facts: The client is now going to earn R30 000 per month and let’s say he/she continue to contribute 15% of his/her earnings towards retirement.
To illustrate I am using a typical portfolio that is Regulation 28 of the Pensions Fund Act compliant with an expected average return of inflation plus 5% per annum, so I currently use an average net return of 11% per annum.
For the purpose of this calculation 1, I want to illustrate how much the investment would be if the client invests the R500 000 with the future contributions of 15% of R30 000 per month, which is R4 500 per month and we assume that the client’s income will increase with 7% per annum.
The second calculation would be as if the client uses the R500 000 for other expenses, in other words how much will the client have at age 65 (after 30 years) if he/she starts over just with the R4 500 per month and the income and contributions that increases annually with 7%.
The third calculation then is then to show how much will the second client need to invest monthly and increase the premium with 7% per annum now to replace the current value of R500 000 in 30 years, age 65?
Two very important facts out of these calculations are the following, and we as Financial Planners has a responsibility to do or to illustrate these calculations to our clients.
1. The retirement capital is 35.80%% less than what it would have been.
2. The scarier fact is that it will cost R3 086 147.24 in future contributions to catch up on the R500 000 taken.
The better choice undoubtedly would be to keep your debt and savings separate from one another and always thrive to never use your savings to settle or reduce debt. Very few clients, if any, succeed in making up the difference through normal recurring investments over the remaining period towards retirement. It is also true that the older the client, the lessor time he/she must catch up as contributions will even be more, and very often, not affordable.
This brings us to a very important question about retirement savings in South Africa:
Should South Africans still be allowed to use their retirement savings before they actually retire?