Saving for retirement is one of the most important aspects of your financial wellbeing. When it comes to planning, it’s important to make sure you know what can increase your retirement savings (compound interest) or what might negatively affect them (fees).

1. Know what you’re paying

Here’s a wake-up call: the amount you’re saving towards your retirement every month is not the amount you’re actually saving.

Andrew Davison, Head of Advice at Old Mutual Corporate Consultants, explains: ‘You get gross contributions (the amount before deductions) and net contributions (the amount after deductions). Your gross contribution is the amount that comes off your salary, and that’s what shows on your payslip. But fees and charges then come off that amount and what’s left is what goes into your retirement savings.’

Charges could include administration fees, advice fees, premiums on group life cover, and so on. If you don’t get a breakdown on your payslip, look at your annual member benefit statement or ask the fund administrator for that information.

2. Get good advice

Even if you don’t have a personal financial adviser, your pension fund’s board of trustees or managing committee may be accessing consulting services, which your contributions help to pay for. These are called advice fees and allow you to benefit indirectly from the advice they receive.

By law, you should also get retirement-benefits counselling when you join a pension fund, resign from it, or retire. This is free of charge.

The workshops held by the retirement fund to which your company belongs are also free of charge, and Davison strongly advises that you attend them. ‘They allow you to ask the questions you’ve been wanting to ask, and learn from your colleagues’ questions,’ he says.

3. Capitalise on compound interest

When it comes to long-term investments like your retirement savings, compound interest is a small thing that makes a massive difference. However, you won’t see its impact for the first few years. ‘This means that it’s often ignored, especially in our age of instant gratification,’ says Davison.

It can also be tough to understand. In essence, it means that you are earning interest on the interest you’ve already earned. Say you’ve saved R100 and earn 4% interest. In the first month, you will therefore earn R4, bringing your balance to R104.

The next month you will earn 4% interest on the full R104, which will amount to R4.16, so you will now have R108.16. In month three, the interest will then be R4.32, taking you to R112.48.
With regards to retirement savings, the amounts will be much bigger, of course, but the principle remains the same. Davison uses the example of a 25-year-old who earns R10 000 a month and gets an increase each year.

‘If you add up all the money they’ll earn before they retire at 65, it’s about R19 million. If their pension is 70% of their final salary and they live until they’re 80, they would need around R20 million to support them for the 15 years between 65 and 80.
‘The money they earned over their 40-year working career therefore was less than the money they need for 15 years of retirement. So even if someone had saved their entire salary while they were working, and only started spending it once they retired, they still wouldn’t have enough.

‘Of course, nobody can afford to save 100% of their salary every month. Most only manage about 15% – the rest will have to come from your investment returns.

‘When you save 15% of the amount you’re going to need in retirement, the other 85% will come from your investment returns. And that’s the magic of compound interest.’

4. Make the most of tax breaks

SARS provides a tax break for retirement savings contributions of up to 27.5% of your salary. That’s nearly double the typical contribution of 15%. While it’s understandable if you don’t get anywhere near this threshold, especially with the rising cost of living, it also means you’re not taking full advantage of the significant tax breaks you could be getting from SARS.

It, therefore, helps to get your retirement savings as close as possible to 27.5% of your salary. ‘You’ll not only benefit from the tax break but you’ll also get used to taking home less money each month,’ Davison says. ‘Once you’ve “acclimatised” to your new budget, you’ll be used to it and won’t have to supplement your pension fund by so much when you retire.’

5. Don’t cash in. Ever.

If you’re thinking of cashing in your retirement savings early (to pay off debt, for example), most financial advisers will tell you the same thing: don’t. You will lose a lot of the benefits of compound interest and find that you’ve dug yourself into a very deep hole. Davison explains: ‘Let’s assume you want to get a pension that’s 75% of what you’re earning just before retiring at 65. To get there, calculate your net contribution rate as a percentage of your salary.

‘If you start at 20, that percentage is 8.6% for men and 9.1% for women. The reason why women have to save more is because they generally live longer than men, but 9.1% is still doable.

‘If you wait until you’re 25 before starting, you’d have to save 10.8% of your salary if you’re a man and 11.5% if you’re a woman. Or if you start at 30, these figures would be 13.8% and 14.6% respectively. Can you see how it’s ratcheting up?

‘At 35, your required contribution rate would have doubled (to 17.8% or 18.9%) from what it was when you were 20. It only gets worse from there. By the time you reach 45, you’d need to contribute more than 30% of your salary, and that’s not even remotely possible.’

The moral of the story, therefore, is to take care of the cents, and the rands will take care of themselves.

This article originally appeared in Today magazine, issue 2 2019. To read the latest issue, click here.