A retirement fund, such as a retirement annuity, a pension or provident fund, is a common way and a great starting point for many people to save for their retirement years. While having a retirement fund is certainly a good step towards achieving financial independence, it is not a guaranteed path to financial freedom.
There are several reasons why relying solely on the fact that you are contributing to a retirement fund may not be sufficient to achieve financial independence.
How much are you contributing?
We advise that you aim to provide for 75% of your salary, adjusted for inflation over time. For a young professional, your retirement fund contribution needs to be set at 17% of your salary and adjusted for inflation over time. For a person closer to retirement, the expectation is that you should have settled all major debt such as your home loan and that your children should be self-sufficient when you retire at around the age of 65.
Based on this, a pension income of 75% of what you used to earn should enable you to sustain your standard of living well into your golden years. If you are to achieve this, the rule of thumb is that you need to accumulate 17x your annual salary after a 40-year working career.
How does your investment perform and grow over time?
Your employer retirement fund is a group scheme, structured to meet the requirements of most people. However, each individual is unique and therefore also has unique needs and circumstances that must be factored into their planning if they are to have a successful retirement.
Therefore it’s important that you have your individualised retirement projections and planning done, that will take into consideration exactly what you need to provide, how much you are able to contribute regularly to an investment portfolio and then at what rate your investments need to grow to help you accumulate sufficient funds for when the time arrives.
Accessing your retirement fund to meet your living and other expenses once retired
The amount you can withdraw from your living annuity (i.e. a post-retirement investment vehicle) is regulated. You can withdraw an income of between 2.5% to 17.5% of your total investment value a year. While this is a broad range, you need to select an appropriate withdrawal rate that will ensure that your pension can last and indeed provide sustained income over your retirement years.
Should I be contributing more to a retirement fund?
Contributions into a retirement fund are tax-deductible up to a maximum of 27.5% of your gross income, with a maximum of R350 000 per tax year.
This does not mean you should not contribute more than the threshold. A retirement fund is a fantastic proposition as no tax is payable on interest earned, dividends received or any of the capital growth achieved while in the retirement fund. Tax is due on withdrawal (where applicable) according to the taxation laws that apply at the time of withdrawal.
Any contributions you make above the threshold allow you to build a tax-free credit that can be applied to your withdrawals at retirement. Along with the assistance of a financial planner, you should determine the appropriate allocation between your retirement fund and discretionary investments that will meet your income requirements once retired.
So, what can you do to achieve financial independence beyond just relying on a retirement fund? Here are a few steps you can take:
1. Create a budget and stick to it. This will help you identify areas where you can cut back on expenses and free up more money to save or invest.
2. Build an emergency fund. Having a separate fund for unexpected expenses can help you avoid dipping into your investment portfolio and overly relying on your retirement savings only.
3. Diversify your investment portfolio. While a retirement fund is a good start, your investment portfolio should have other types of discretionary investments that will allow you to access funds readily when you require money over and above the monthly payment you receive from your annuity.
4. Work with a financial planner. A financial planner can help you create a comprehensive retirement plan that takes into account your goals, your risk tolerance, and other factors and then structure an income plan that will ensure that both your monthly and ad-hoc expenses are provided for sufficiently and can be met.
While a retirement fund is certainly an important part of your investment portfolio and a means of securing your financial independence, it needs to be used in a broader retirement planning strategy that ensures that you maintain a diversified portfolio, that you can maintain an emergency fund, that your income can increase and keep up with inflation and that both your monthly and ad-hoc income needs are provided for and can be met when they become due.
Written by Palesa Dube, CFP®
Dube is certified financial planner and a director and wealth manager at Wealth Creed. She is a practising member of the Financial Planning Institute of Southern Africa and is the Financial Planner of the Year 2022.