Here’s how to make your retirement funds last longer

Retirement planning often emphasizes the need to save before entering the golden years, but a key question remains: "How much can I safely spend each year without running out of money?" Momentum Investments’ Martiens Barnard sheds light on why the popular 4% to 5% retirement income rule of thumb remains relevant, even as many South African retirees may be drawing more than their savings can support.

This rule of thumb is not a precise formula; rather, it’s an experience-based principle designed to enhance decision-making and outcomes in financial planning. Over decades, this principle has guided retirement decision-making. The 45th Sanlam Benchmark Survey revealed that South African pensioners who take a cash lump sum at retirement typically exhaust their funds within a year and a half.

The guideline for a 4% to 5% withdrawal rate originates from William Bengen’s research, which demonstrated that withdrawing around 4% in the first year of retirement, with inflation adjustments each year, could sustain income for 25 to 30 years. However, the behavior of the South African market paints a different picture. Many retirees exceed this recommended guideline, straining their retirement savings and jeopardizing the long-term sustainability of their income.

Barnard highlights five critical risks that determine whether retirement income lasts:

1. Drawing too much income – A drawdown rate that is too high is a common mistake. Higher withdrawals necessitate higher returns to maintain income sustainability, increasing reliance on market performance and reducing the safety margin.

2. Market risk and sequence risk – Markets are unpredictable, and retirees face short-term losses as well as potential long-term underperformance. Sequence risk, the order of returns, compounds this issue.

3. Inflation risk – Over time, inflation erodes purchasing power. Income that doesn’t keep pace with rising living costs will fail to meet retiree needs.

4. Behaviour tax – Emotional decision-making during market volatility, such as switching investments, often reduces long-term value.

5. Longevity risk – With increasing life expectancy, more retirees face the challenge of their income lasting 30 years or more.

To achieve a sustainable income, Barnard suggests starting with a 5% initial drawdown, with withdrawals increasing annually by 5%. This approach assumes a net return of about 8.2% annually to maintain living standards. However, starting with a lower initial rate, such as 7%, would require a higher net return of over 11%. Missing this higher target by just 2% could shorten income sustainability by up to a decade.

Barnard emphasizes that these risks and other aspects of retirement, such as inheritance, are explored in a series of insightful videos to help clients and financial advisers make better retirement decisions.