Knowing your replacement level at every stage of investing for retirement is crucial for effective retirement planning. As you progress through different stages of life and investing, your financial needs and goals will evolve, and understanding your replacement level at each stage will help you make informed decisions and stay on track for a comfortable retirement.
But first, what is a replacement level? Also called your funding level, or replacement ratio, it’s simply a projection of the percentage of your last monthly salary that you can take as a sustainable, post-retirement income. For example, if you earn R10 000 a month just before retirement, and your replacement ratio is 75%, you’ll have an income of R7 500 a month.
However, recent research suggests that many retirees won’t be able to enjoy such a high replacement ratio and that the average projected replacement level is closer to 40.5% (according to an Alexander Forbes study). If you’re nearing the end of your career, it can be very difficult to make up for this shortfall. However, if you’re younger, there’s still time to take corrective action. Let’s look at different stages of investing for retirement:
- Early career stage: During the early career stage, you may have just started saving for retirement and have a long investment horizon. Knowing your replacement level at this stage helps you establish a baseline of how much you’ll need to save. Calculate how much of your current income you need to replace in retirement, considering your desired standard of living, expected expenses, and inflation. This knowledge will guide you in determining the appropriate savings rate and investment strategy to reach your retirement goals.
- Mid-career stage: In the mid-career stage, you may have already accumulated a significant amount in your retirement savings. Revisiting your replacement level becomes essential to assess whether you are on track to meet your income goals in retirement. Your income and lifestyle expectations may have changed since the early career stage, and it’s crucial to reevaluate your retirement needs. Consider factors such as changing family dynamics, housing costs, healthcare expenses, and major financial obligations. Adjust your replacement level accordingly and reassess your savings contributions and investment allocation to ensure you’re on track.
- Late career stage: Knowing your replacement level becomes even more critical as retirement draws closer. At this stage, you need to clearly understand the income you’ll need to maintain your desired lifestyle throughout your retirement. Evaluate how well your savings align with your replacement level and make any necessary adjustments. This might involve increasing your savings rate, making catch-up contributions, or exploring additional income sources to bridge gaps.
- Pre-retirement stage: As you approach retirement, it’s essential to refine your replacement level calculations further. Carefully consider any other sources of capital, such as any discretionary investments (i.e., not in a retirement fund) and the property you may own. Could you downsize to a smaller dwelling when you retire, sell your holiday home, and add the capital you’ve gained to your retirement capital? Determine the percentage of your pre-retirement income covered by these sources and identify any remaining gaps. This knowledge will help you further fine-tune your savings plan and ensure a solid financial foundation for retirement.
- Post-retirement stage: Even in retirement, it’s important to reassess your replacement level periodically. Monitor your spending patterns, lifestyle changes, and potential healthcare costs. Stay informed about inflation and interest rates and adjust your retirement income accordingly – living annuity products allow you to change your withdrawals yearly as necessary. Review your investment strategies, considering conservative options to ensure the sustainability of your retirement savings while including more aggressive opportunities to generate growth.
In summary, knowing your replacement level at each stage of investing allows you to set realistic savings targets, assess your progress, and make informed decisions about your investments. You can secure a comfortable and financially sound retirement by staying proactive and adjusting your strategies accordingly.
Sumayya Davenhill is head of marketing at M&G Investments.
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