Use the two pot system wisely and reach all your goals

The two-pot retirement system has been designed to give you access to your retirement savings when you have a financial emergency, with no other option but to use these savings.

Withdrawing from your retirement savings without doing anything else to get back on track financially, can compromise your financial future.

But this doesn’t mean there is no hope for you if you are financially compromised. The key is knowing how to work the system.

How much do you need to retire comfortably?

A comfortable retirement means being able to maintain the standard of living to which you are accustomed for the duration of your retirement, Paul Hutchinson, sales manager at Ninety One, explained at a recent Women and Investing webinar.

If you want a pension that is equal to the salary you are earning when you reach retirement, you need to have savings of 20 times your annual salary in your last working year, he says.

That can be a scary number, Hutchinson says. It means that if you are earning R1 million a year, you need R20 million in savings at retirement, and if you are earning R240 000 a year, you need R4,8 million in savings.

But if your debt is paid off by the time you retire and you no longer have dependants, you can probably retire comfortably on 75 percent of your final salary, he says.

To provide a pension equal to 75 percent of your final salary, you will need 15 times your annual salary saved at retirement.

You then need to be sure your savings can provide for a potential 30 years lifespan in retirement, and so if you invest to provide a pension, you should start by not drawing more than five percent a year of your savings when you retire, Hutchinson says.

How can I save that much?

In order to accumulate that amount of savings, Hutchinson says, you need to:

• Contribute 15 percent of your income to your retirement fund from your first pay cheque until the last one over a 40-year working life. If you are employed, your employer may pay a portion of the 15 percent.
  
  
• Invest in sufficient growth assets such as equities and listed property to enable your savings to grow by inflation plus five percent.
  
  
• Preserve your savings without withdrawing at any stage.

Hutchinson says if you start saving later in your working life, or you save less than 15% of your salary into your retirement fund, you will have to save at a much higher rate to catch up or retire later so you can still have a 40-year working life.

He learnt this hard lesson himself because he had a family at a young age and reduced his retirement fund contributions from 15% to 10% of his salary to make ends meet.

Hutchinson said he made the mistake of not increasing his contributions again when his financial situation improved. “I missed out on the compounding effect of contributions equal to 15% of my salary because I was only contributing 10% for a number of years,” he said.

Now in his 50s, he is contributing 23 percent of his salary instead of 15 percent to get his retirement savings back on track, he says.

The magic of compounding

Hutchinson says after the first ten years of your working life, you should have two to three times your annual salary saved.

HOW TO RETIRE COMFORTABLY
The goal: At least 15 x annual income    Assuming you: - Save 15% of your income; and - Earn a return of inflation plus 5%.
After 10 years	2 to 3 x your annual income
After 20 years	5 x your annual income
After 30 years	10 x your annual income
After 40 years	20 x your annual income
Source: Ninety One

If you don’t save at all for the first ten years of your working life, you will need to double your contributions from15 percent of your income to 30 percent in order to ensure you have saved 15 times your income by retirement after working for 40 years.

If you have two to three times your annual income after ten years of working, compounding returns on your savings and your ongoing contributions will grow those savings into five times your annual income after 20 years of working life, he says.

After this your savings will compound faster, and after another 10 years you should have 10 times your annual income, and the last 10 years of your 40-year working life will get you to 20 times your annual income, Hutchinson says.   

Breaking the formula

If you are saving 15 percent of income for retirement, when the two-pot retirement system becomes effective from 1 September 2024, you will save five percent in the savings pot (one third of your contributions) and 10 percent in the retirement pot, Hutchinson explains.

If you withdraw all the savings in your savings pot, you will only be saving 10 percent a year for retirement and this will seriously compromise your ability to save 15 times your annual income at retirement and therefore your ability to retire comfortably, he says.

The upside

Under the current retirement system, most members withdraw all their savings each time they change jobs, resulting in the typical member retiring with just 2.7 times their annual income in savings and a much-reduced income in retirement, Keri-lee Edmond, the Analytics and Insights Manager from Old Mutual Corporate Consultants, writes in a recent article published on EBNet.

A member forced to preserve their retirement pot over their entire working life from age 25 until retirement should retire with a much higher amount of around 9.5 times their annual salary, she says.

Making it better

Young members who have the benefit of time on their side can, with just a small adjustment to their contributions, use their savings pot to improve their financial lives by, for example, paying off unsecured debt or providing for a child’s education, while still retiring with an adequate amount, John Anderson, executive for solutions and enablement at AlexForbes, says.

The AlexForbes actuarial team’s calculations show that a member with an income of R29 200 who increases their contribution to their retirement fund by just R292 a month, would have R216 less in take home pay.  

This additional contribution could be used to repay debt – the calculations assumed this is costing the member 35% of their income but could be repaid within three years, freeing up R3 000 a month.

The additional one percent contribution could after 18 years also provide enough to pay the equivalent of R60 000 a year in tertiary education fees for three years. The member would still have enough to retire at age 65 with a pension equal to 70 percent of their final salary, AlexForbes found.

Giving up R216 of take-home pay would be much cheaper than the R1 200 a month cost of a policy to fund the education of a child in 18 years’ time, the calculation also shows.    

Anderson says the calculations show that if you view your savings pot as a means to an end, rather than easily accessible money, you can, with the right financial guidance achieve both your short and long-term financial goals.