Time in the market and investment growth do most of the heavy lifting required to secure a comfortable retirement. However, the level of contributions made throughout a member’s working life is equally important for achieving the desired retirement outcomes.
Contributions benefit from compound growth and can accumulate into a reliable source of financial security for members. Conversely, under-prioritising them can create a significant gap between expected and achievable retirement outcomes, leading to budget constraints when members begin to draw an income.
How do we know if members are on track?
The replacement ratio is often used to assess retirement readiness. This measures the proportion of a member’s final salary that can be sustained in retirement. A commonly referenced target is
approximately 75%, yet relatively few South Africans achieve this level, highlighting the importance of considering contributions relative to the retirement income they are expected to generate
What does a good contribution strategy look like?
While there is no one-size-fits-all approach, a structured plan and discipline are key. Members need to have a clear budget and live within their means, as this makes it easier to identify how much income needs to be replaced when working is no longer an option.
Changing contribution levels throughout one’s career can influence retirement outcomes in very different ways.
Graph 1 compares four contribution journeys for Individual X, and their respective replacement ratios achieved over time. Individual X starts their career at age 25, earns a gross monthly salary of R30 000 – adjusted for 5% inflation annually over a 40-year investment horizon – and has no accumulated retirement investments. The projected outcomes – in other words, the replacement ratio achieved as shown in the brackets on the graph – are based on an assumed nominal growth rate of 11% (inflation plus a real return of 6%), with no previous withdrawals, no additional contributions and a 4% drawdown rate in retirement, with the goal of achieving a 75% replacement ratio.
- Journey one (black): The steady contributor
This illustrates the projected replacement ratio achieved if Individual X contributes a flat 12% of their inflation-adjusted salary throughout their career. -
Journey two (grey): Starting small and increasing as the years pass
This illustrates the potential replacement ratio achieved if Individual X contributes 10% of their inflation-adjusted salary for the first 10 years of their career, then scales up the contribution amount to 20% in increments of 1% per year.Journey three (red): A phased approach to investing more
This illustrates the replacement ratio that could be achieved if Individual X initially contributes 12% of their inflation-adjusted salary, before increasing contributions by 1% per year until reaching 15%. This rate is maintained until age 45, after which contributions increase by a further 1% per year until reaching 20%, which is then maintained until retirement.Journey four (lilac): Front-loading retirement investing
This illustrates the projected replacement ratio that could be achieved if Individual X contributes 25% of their inflation-adjusted salary, before scaling contributions down by 1% per year until reaching 5%, then maintaining the 5% contribution rate until retirement.
So, members who contribute a higher percentage of their salary, and increase this percentage in the long run, generally achieve stronger retirement outcomes. While contributing around 10% to 12% is the current industry average, this isn’t enough to achieve a 75% replacement ratio over a working lifetime, as illustrated by the black line (Journey one). However, as shown by the grey and red lines (Journeys two and three), gradually increasing contribution percentages over the long-term has a positive impact, which is particularly pronounced where the investment manager outperforms the long-term industry return average of 11%. Meanwhile, the decision to make elevated contributions earlier – a less common scenario – allows compound growth more time to work, as shown by the lilac line (Journey four).
Employers and consultants should encourage members to think about what percentage of their salaries they should be investing now to fund their later years. There are tools that aim to give members a clear picture of what they will need to do to improve their outcomes – which could include delaying retirement where possible. Many umbrella fund providers, including Allan Gray, make them available on request for active schemes.
What happens when members access retirement investments early?
Two-pot legislation allows members to access the savings component of their retirement fund once per tax year.
Based on the modelling in Graph 1, Table 1 highlights the consequences of Individual X accessing their savings component through consistent annual withdrawals in varying percentages, and Table 2 highlights the potential outcomes of making a once-off withdrawal; and how these actions affect replacement ratios over time.
The long-term effect of both scenarios is dramatically lower investment values and a reduced ability to replace income in retirement.
Making time count
Ultimately, sufficient contributions started early enough and made consistently, combined with prudent manager selection, appropriate asset allocation and sound investor behaviour, should lead to positive outcomes.
