Retirement Savings May Dwindle in Just 14 Months
Many people talk about the importance of saving for retirement, but then there’s the big question: what really happens once you retire? Retirees often wonder, “How much money can I safely withdraw each year without depleting my savings?”
Martins Barnard, a marketing actuary at Momentum Investments, sheds light on why the 4% to 5% guideline for retirement income is still relevant today. He notes that many retirees in South Africa are actually spending more than they can afford based on their savings.
It’s important to remember that these rules are not precise formulas. Instead, they serve as general principles to help people make informed decisions. The retirement income rule has guided financial planning for years, which is particularly crucial as people get closer to retirement.
Guidelines for Retirement Income
According to findings from the 45th Sanlam Benchmark Study, South African pensioners typically receive a lump sum at retirement, but interestingly, they often spend it within just over a year.
Barnard explains that the 4% to 5% withdrawal suggestion comes from research by William Bengen, indicating retirees could withdraw about 4% in the first year, adjusted for inflation, to sustain their income for 25 to 30 years.
However, the reality for many in the South African context suggests otherwise. A lot of retirees exceed these guidelines, which can strain their savings and threaten the long-term sustainability of their income.
Reassessing Retirement
Barnard points out five key risks that will impact the longevity of retirement income.
Excessive Withdrawals – Many retirees make the mistake of starting with too high a withdrawal rate. A higher drawdown means they need to chase higher returns, which increases reliance on market performance and reduces their safety net.
Market and Sequence Risk – Market fluctuations don’t follow a straight path, and retirees face the risk of short-term losses and possible average long-term underperformance. Sequence risk, reflecting the order of returns, compounds this issue. If retirees face poor returns early on while still withdrawing funds, it can permanently damage their capital, leaving them more vulnerable than those still in the accumulation phase.
Inflation Risk – Over time, inflation chips away at purchasing power. Retirees often see their income grow more slowly than the rising cost of living, which can create budgetary challenges. This is sometimes an overlooked threat that can derail financial plans.
Behavioral Costs – The ‘behavior tax’ refers to the mistakes made when switching investments, particularly during emotionally charged times, like market downturns. These decisions can often lead to long-term losses in value.
Longevity Risk – With increasing life expectancies, many retirees are confronted with the possibility of needing to fund their lifestyles for decades. This risk amplifies if one withdraws too much, lives longer than anticipated, or encounters market instability.
Creating a Sustainable Income
Barnard discusses the balance necessary to maintain a sustainable income in retirement:
The recommended starting drawdown of 5% (with that amount increasing by 5% annually) assumes retirees will earn a net return of around 8.2% each year to keep up their lifestyle.
If a retiree starts with a 7% withdrawal rate, they would need a net income of over 11% to stay secure.
Missing the 11.2% return target by only 2% could potentially cut the sustainability of income by a decade.
“All these risks and other retirement-related aspects are broken down in a series of concise videos designed to assist clients and advisors in making informed retirement decisions,” Barnard adds.
