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%.
The exponential benefits of delaying retirement on savings
If a 4% withdrawal rate will not provide you with sufficient income, it may be worth giving serious consideration to delaying your retirement.
Remember, your salary and therefore retirement contributions are usually at their peak in the years just before your retirement, and when combined with the added effect of delaying dipping into your capital, these last few years can make a huge difference to your portfolio through the power of compounding.
To demonstrate the enormous impact of an extra few years on your savings, the graph below compares three scenarios involving the same investor who has accumulated a R10 million capital lump sum at age 55 years.
1. Retires at 55 years
In the first scenario, the individual retires at the age of 55 years, and chooses to adopt a 5% annual withdrawal rate. Assuming that inflation rises by 6% every year and that their investment achieves growth of 8.5% every year (or 2.5% real growth), their capital would be depleted at the age of 83 years.