How much do you really need for retirement?

The state pension is R1,260 a month. How do pensioners make it?

By my calculation, one would need R1,000 a day to be able to pay for the running costs of a home, car and medical cover and still afford a modest lifestyle.

So how does a 40-something wishing to retire at the age of 65 on a R1,000-a-day inflation-proof pension accumulate the capital over 25 years?

To clear R1,000 a day — R30,000 a month — on a taxable pension, the pre-tax equivalent would have to be R38,750. Yes, even pensioners pay tax. But the age rebates and the annual adjustment of the tax tables over the past 15 years have reduced the average rate of tax to 22%.

Those in the know say that pensioners should not be drawing more than 8% of their retirement capital per year. Thus, to generate the above pension, one would need about R6m retirement fund capital.

Using a private portfolio and drawing down tax-free capital in retirement would require less — about R4.6m.

But just try to accumulate R4.6m in an interest-bearing savings account with inflation running at 6% and after-tax interest rates of about 3.5%. Answer: save R20,800 a month.

Being a little more optimistic, assume that a carefully balanced private equity portfolio could achieve 9% growth over 25 years. Answer: invest R10,900.

Turning to retirement funds, the taxpayer enjoys a tax deduction on contribution and tax-free growth in the fund. But they have to fund the tax on the pension annuity. So, increase the return to 10% and the target to R6m. Answer: contribute R12,500.

Retirement fund contribution is tax deductible. So, if the investor is subject to the maximum rate of tax of 40%, the after-tax contribution reduces to R7,500.

Conclusions: rather move in with the kids than base a pension plan on taxable interest returns. A private portfolio may be the answer if you are in receipt of taxable income below R258,000 a year and the maximum marginal tax rate is below 30%.

Earning above R258,000 a year, the value of the tax deductions on retirement fund contributions, coupled with tax-free growth while invested, just cannot be beaten.

But what are we doing to encourage retirement planning for lower-income earners? The proposed tax-free preferred savings account returning perhaps 5% is just not going to do the trick.

Originally published in the Sunday Times: Money & Careers Tax Talk column.

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