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Financial PlanningRetirement

Lower salary increases mean less retirement savings

But working longer can help 

Twane Wessels

Wage freezes have and will continue to be a reality for many people as South Africa battles the COVID-19 pandemic and its destructive impact on the local and global economies. 

Salary increases have been trending downwards for several years.  Gone are the days before the Great Financial Recession when top performers could achieve double digit increases. Now, increases in line with inflation are more likely. 

According to a salary trends report from PEC Corporate Services, over five years to the end of 2019 salary increases have, on average, only beat inflation by 1.4%, including increases for promotions.

What effect can a zero percent increase have on retirement savings?  As contributions to employer pension or provident schemes are based on a salary percentage, the answer is clear.  The lower the increases, the lower the contributions to an employee’s retirement fund will be, as well as the amount of their employer’s contribution. And the less money they have invested to capitalise on any investment growth.

When you consider that most South Africans retire without sufficient savings, a lack of decent increases will exacerbate the problem, says Twané Wessels, Product Actuary at retirement income specialist, Just.

One way to help address this is to work for longer, providing an employer allows this.  Wessels looked at the impact of working up to five years longer to boost retirement savings.  She began with a retirement age of 65 and looked at the impact of adding savings between 0% to 20% of an employee’s annual salary over the following five years.  She considered different rates of real (after inflation) returns on these savings, from 1% to 7%.

If people continue to make contributions to their retirement fund for a further five years after age 65, their replacement ratio will improve substantially, particularly if they have not saved enough.  Replacement ratio is a rule of thumb that estimates what percentage of a person’s pre-retirement income can be achieved in retirement.

If, for example, they have only saved the equivalent of one year of their current salary and make no further contributions and receive no further salary increases, deferring their retirement by five years can improve their replacement ratio from 10% to between 12% and 16%. The range depends on whether their savings earns between 1% and 7% real investment returns. If, instead, they save 10% of their monthly salary during the five years of deferment, they can further improve their replacement ratio to between 18% and 23%. And if they are lucky enough to be able to save 20% of their salary, they can improve their replacement ratio to between 24% and 30%.

If, on the other hand, they have accumulated 5 times annual salary and they continue with a 20% contribution rate during the five years of deferment the replacement ratio can be improved from 50% to between 73 and 95%.

“Working longer can help with retirement readiness, and continuing to save as much as possible while deferring a formal retirement date is very important.”

A ‘side hustle’ or some consulting work in the years leading up to retirement can also boost the retirement savings pot, as the same benefits apply to any additional money saved.




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