Early retirement is tempting – but can you afford it?

The temptation to retire early and adopt a life of leisure can be particularly seductive as you enter your fifties and sixties, especially after many years spent with your nose to the grindstone. But can you afford it?

 

There are two main drivers which determine if early retirement is even an option for you. They are:

  •        How much capital you have, and

  •        How much you need to draw to sustain your standard of living.

 

Clients often ask us “How much capital will I need to retire”?  However, the answer is directly related to how much you require on a monthly basis to sustain your current standard of living.

 

One of the very basic calculations I give my clients is to take their current monthly expenditure, divide this number by four and multiply it by R1,000. This calculation works when you are still trying to accumulate your capital and need to set a retirement savings target.

 

If you are already at retirement age, however, ensuring that your capital will last your entire lifetime, which is generally unknown, becomes more important. To be conservative, I would suggest that you draw no more than 4% of your retirement capital on an annual basis.

 

To demonstrate the significance of this, the graph below shows how withdrawal rates affect how long your capital will last.

 

The graph is based on the example of an individual who retires at 55 years with capital of R10 million, and further assumes that inflation rises by 6.0% per annum and that their investment achieves annual growth of 8.5%:

 

By keeping their withdrawal rate to 4%, their retirement capital would sustain them until the age of 95 years. However, by increasing their withdrawal rate to 4.5%, their capital would be depleted by the age of 87 years. A 6% withdrawal rate would mean that their capital would run out at the age of 77 years – nearly twenty years earlier than had they stuck to 4%.